Lesson 5 in Microeconomics Owner's note: the content is not mine.. Credit to the author of the book.. Making the ppt presentation is mine.

1. Lesson 5: The Price System and The
Mixed Economy
By: But, Judy Ann A.

2. Objectives
 Examine the framework of pure market
economy and show how the circular flow of
income and expenditure in a capitalist economy
keeps it functioning;
 Explain how the price system allocates
resources in terms of what is produced, how it
is produced and how it is distributed; and
 Identify the defects of pure market system; and
 Give a brief outline of how the modern, mixed
and open economy function.

3. Capitalism and the Market Economy
 Capitalism is an economic system characterized by
private ownership of economic resources and
freedom of enterprise in which owners of factories
and other capital hire workers to produced goods
and services.
 Mixed Economy. Provides goods and services to
government as well as business firms in such
economies governments supply roads defense,
pensions, and schooling directly to citizens. They
also commonly intervene in markets to control and
correct prices.
 Price System is a mechanism by which resource
use in a market economy is guided by price.

4. Characteristics of Capitalism
 Freedom of Enterprise. The right of business firm
owners to employ private economic resources for
whatever purpose they want.
 Economic Rivalry. A situation in which large
numbers of buyers are competing for available
supplies of goods and services for sale in markets.
 Free Markets is the situation which exists when
there are no restrictions that prevent buyers or
sellers from entering or exiting from a market.

5. Specialization and Exchange
 Specialization and division of labor mean that
workers and entrepreneurs spend most of their
time in producing one or a few goods and services.
These specialist sell the goods and services they
specialize in and then use their income to buy
goods and services they want that are offered for
sale by other specialists. Such exchange allow
mutual gains to the traders.
 Barter is the process of exchanging goods for
services or vice versa. This is an inconvenient
means of exchange because it requires double
incidence of wants.

6. How Production Generates Income in the Market
Economy: Circular Flow of Income and Expenditures
 Business firms are buyers of resources offered for
sale in input markets. Households supply economic
resources as sellers in these input markets. The
competition among the many buyers and sellers of
inputs results in market prices for labor, the use of
funds, capital and natural resources. The prices
depend on conditions of supply and demand in each
input market.

7. How the Price System Influences
What is Produced
 What gets produced in a market economy is
determined chiefly by profitability.

8. How the Price System Influences
Production Market
 The pursuit of profit also influences how goods
and services are produced. Business firms can
earn more profit by producing any given
quantity of goods.
‘Who Gets the Goods and Services?
Your ability to buy goods and services in
product markets depends on your ability to
register a demand for products. Demand is much
more than the desire for an item. Demand is a
desire that can be backed up with the willingness
and ability to pay. It is on this basis that the
price system allocates goods and services among
consumers. Your ability to pay in turn depends
greatly on your money income.

9. Some Common Defects in the Prices System
 Pubic Goods are those consumed equally by
all of us, whether we pay or not. Example:
Environmental protection and national
security. These public goods benefit all of
us, regardless of whether we are tax payers
or not.

10. Box 1: The Circular Flow of Income and
Expenditure in a Market Economy
Product
Market
Business
Firms
Input
Market
Households

11.  Business Firms acquire resources for households
in input markets. The income earned by
households is then spent on goods and services
offered for sale in product markets by business
firms.
 One common problem in a pure market economy is
that not all the goods we want and paid for willingly
can easily be sold in neat packages that can be
priced.
 Externalities are cost or benefits of market
transaction that are not reflected in the prices
buyers and sellers use to make their decision.

12. Other Common Problems in a Market System
 Lack of Competition
 impairs the ability of the price system to
respond to changes in demand. Monopolization
of supply prevents profits from serving as a
signal for entry of new firms and more output
in market in which additional output from
serving would be profitable.

13.  Income Inequality and Poverty
 In pure market economy, income depends
entirely on the quantity, quality and types of
resources of people are able and willing to sell.
Income influences the willingness and ability to
pay for goods. People with very low income
maybe unable to buy the minimal amounts of
goods and services required for their survival.

14.  Instability
 Fluctuations in demand and supply and
consequent periods of market disequilibrium
are an inherit problem that results from lack of
coordination of decision making in the price
system.

15. Modern Mixed and Open Economy
 There is another circular flow of expenditures
and income where the governments fits into
Governments participate in input markets of
purchasing labor and other productive
resources. They borrow funds from credit
markets when their expenditures exceed their
tax revenue. Governments also participate in
product market to purchase the output of
business firms.

16. The Role of the Government
 Although governments seeks to correct the
defects in the price system, it is also has an
impact on revenue use. When voters approve
programs for which marginal cost exceeds
benefits there is government failure because
resources are allocated to be used for which the
net gain is negative.

17. Basic Functions of Government
 Establishment of rights to use productive
resources and the regulation of private action.
Government guarantees rights and enforce
contracts. It serves as a rule maker and rule
enforcer in the economy.
 Provision of goods and service. Government
purchases input services to provide national
defense, education, roads and health services.
 Redistribution of income. Welfare programs,
government Social Security pension and
subsidies are being established and
administered to distribute income among
citizens.

18. Government transfers are payments made
directly to certain people in organization that do
not provide a good service in return at a given
time.

19. Product
Market
Business
Firm
Input
Market
House
Holds Government
Income
Taxes
Subsidies
Taxes
The Mixed Economy
Government
Service
Government
Service

20. The mixed economy, governments compete in
input markets and product markets to obtain the
resources and products they need to supply goods
and services. Governments obtain funds to finance
their operation by taxing households and business
firms and by borrowing in credit markets.
Governments use some of their revenues to provide
income support to the elderly, the poor, and other
groups and also to subsidize some business firms.
 Stabilization of the economy. The government
pursues policies designed to affect the overall level
of demand and supply in the economy so as to
control economic fluctuations. This is achieved
through control of the government’s spending and
taxation and through control of the nation’s supply
of money and credit.

21. Categories of Government Provided Goods
 Goods that are made available to all citizens free of
charge, the cost of which are financed by taxes or
borrowing.
Example: National defense, public health, sanitation,
roads and bridges.
 Goods and services that are tax financed but are
available only to individuals who meet
predetermined eligibility criteria.
Example: Public education is provided only to people
of a certain age.

22. Principles of Taxation
The bulk of government spending is
financed by taxes which are compulsory payment
associated with income, consumption or wealth
that individuals and corporations are required to
make each year to governments.

23. Tax Equity- Different Points of View
 Regressive tax is one for which the fraction of
income used to pay it decrease as income
increases.
 Progressive tax is one for which the fraction of
income paid increases as income increases.
 Proportional tax is one for which the percentage
of income paid in taxes is the same no matter
how much the taxpayer’s income is.