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Chapter 2: Markets and government in a modern economy

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Title: Chapter 2: Markets and government in a modern economy


1
Chapter 2 Markets and government in a modern
economy
  • what is market and what is the invisible hand
  • how market solve the basic economic problems
  • the economic role of government
  • Different terms
  • trade, Money and Capital.

2
Learning Objectives
  • 1. Describe what is meant by the term market and
    describe the process of achieving equilibrium in
    a market economy.
  • 2. Use your definition of market equilibrium to
    address three basic economic problems that
    confront all societies.

3
Objectives
  • 3. Explain how the price system works as an
    invisible hand, allocating goods and services in
    a market economy.
  • 4. Use a circular-flow diagram to illustrate the
    relationships between agents and markets in a
    modern economy.

4
Objectives
  • 5. Make a case for government intervention in a
    mixed market economy in order to promote
    efficiency, equity, and macroeconomic growth and
    stability.

5
Market definition
  • A market is the institution through which buyers
    and sellers interact and engage in exchange.
  • A market economy has at its heart the actions of
    buyers and sellers who exchange goods and
    services with one another.

6
A. What Is a Market?
  • There is no higher authority that directs the
    behavior of these economic agents rather, it is
    the invisible hand of the marketplace that
    allocates final goods and services, as well as
    factors of production.

7
Markets
  • Buyers and sellers receive signals from one
    another in the form of prices. If buyers want to
    buy more of a good, prices rise and sellers
    respond by supplying more to the marketplace.

8
Markets
  • If buyers want to buy less of a good, prices fall
    and sellers respond by supplying less to the
    marketplace.

9
Markets
  • Market equilibrium occurs when the price is such
    that the quantity that buyers are interested in
    purchasing is equal to the quantity that sellers
    are interested in supplying to the market.

10
Markets
  • The market mechanism allows an economy to
    simultaneously solve the three economic problems
    of what, how, and for whom.

11
Economic problem
  • The economic problem Given scarce resources,
    how, exactly, do large, complex societies go
    about answering the three basic economic
    questions?
  • To answer the three basic questions we need to
    study the economic systems.

12
Economic Systems
  • Economic systems are the basic arrangements made
    by societies to solve the economic problem.
  • They includes four systems

13
Systems
  1. Islamic economy
  2. Laissez-faire economies
  3. Command economies
  4. Mixed systems

14
Islamic Economy
  • Some people think that Islam has no economic
    system of its own
  • Islamic Economics is as Old as Islam Itself

15
Islamic Economy
  • Islamic economics is accordance with Islamic law.
  • Islamic economics can refer to the application of
    Islamic law to economic activity either where
    Islamic rule is in force or where it is not

16
I.E
  • i.e. it can refer to the creation of an Islamic
    economic system, or to simply following Islamic
    law in regards to spending, saving, investing,
    giving, etc. where the state does not follow
    Islamic law.

17
Definition of Islamic economics
  • The Islamic economics is both a science and an
    art which deals with the daily routine of a
    Muslim's economic life.
  • i.e. how he earns his income and how he spends
    it. It is a science in the sense that it involves
    many scientific methods in the production of
    material goods, their distribution and
    consumption.

18
Principles
  • The Islamic economic system is directly guided by
    Allah Almighty Himself.
  • all important aspects of the Islamic economic
    system and the applicable norms are thoroughly
    discussed in the Holy Quran

19
Cont.
  • Allah created all needed provisions so that they
    may consume them and may satisfy their wants

20
Other principles
  1. All wealth belongs to Allah (SWT(
  2. The Muslims are the custodians and trustees of
    the wealth.
  3. Hoarding the wealth is forbidden.
  4. Circulating the wealth is obligatory

21
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22
The free market system
  • In a laissez-faire economy, individuals and firms
    pursue their own self-interests without any
    central direction or regulation.
  • The central institution of a laissez-faire
    economy is the free-market system.
  • A market is the institution through which buyers
    and sellers interact and engage in exchange.

23
Consumer sovereignty
  • Consumer sovereignty is the idea that consumers
    ultimately dictate what will be produced (or not
    produced) by choosing what to purchase (and what
    not to purchase).

24
Free enterprise
  • Free enterprise under a free market system,
    individual producers must figure out how to plan,
    organize, and coordinate the production of
    products and services.

25
distribution of output
  • In a laissez-faire economy, the distribution of
    output is also determined in a decentralized way.
    The amount that any one household gets depends
    on its income and wealth.

26
Free System
  • The basic coordinating mechanism in a free market
    system is price. Price is the amount that a
    product sells for per unit. It reflects what
    society is willing to pay.

27
Command economies
  • In a command economy, a central government either
    directly or indirectly sets output targets,
    incomes, and prices.
  • And the government determine what to produce and
    how much and How and for Whom to produce.

28
Mixed Systems, Markets, and Governments
  • Since markets are not perfect, governments
    intervene and often play a major role in the
    economy.
  • Some of the goals of government are to

29
goals of government in mixed economy
  • Minimize market inefficiencies
  • Provide public goods
  • Redistribute income
  • Stabilize the macro economy
  • Promote low levels of unemployment
  • Promote low levels of inflation

30
The Market System Relies on Supply and Demand to
Solve the Trio of Economic Problems
31
The Basic Decision-Making Units
  • Firms and Households and An entrepreneur

32
A firm
  • A firm is an organization that transforms
    resources (inputs) into products (outputs).
    Firms are the primary producing units in a market
    economy.

33
An entrepreneur
  • An entrepreneur is a person who organizes,
    manages, and assumes the risks of a firm, taking
    a new idea or a new product and turning it into a
    successful business.

34
Households
  • Households are the consuming units in an economy

35
Input Markets and Output Markets The Circular
Flow
  • The circular flow of economic activity shows how
    firms and households interact in input and output
    markets.

36
B. Trade, Money, and Capital
  • Advanced economies use complex systems of trade
    in order to accumulate the bundle of goods and
    services that the people in that economy want to
    consume.

37
Cont.
  • People produce the goods and services that they
    can produce most efficiently, and then they trade
    their excess for other items that they need.

38
Money
  • Money is not an input or factor of production.
    Consumers and firms use money in order to more
    efficiently carry out market transactions it is
    a kind of lubricating oil that allows the
    machinery of an economy to operate with a minimum
    of friction.

39
Capital
  • In this course, the term capital does not refer
    to money. Instead, the term refers to productive
    inputs.

40
Cont.
  • capital includes durable items like factory
    buildings, machine tools, electric drills, jack
    hammers, and so on. It also includes stocks of
    semi finished goods. These are goods which are on
    the way to becoming consumer goods but which are
    still manufactured inputs to be used in later
    stages of the production process.

41
Capital accumulation
  • Capital accumulation is an important determinant
    of economic growth. An economic system that
    builds a strong capital base is investing in a
    factor of production that will make all other
    factors more productive or useful.

42
The Economic Role of Government
  • In the real world, markets do not always operate
    as smoothly as we might like. Market
    imperfections lead to a wide range of problems,
    and governments step in to address them.

43
Gov. intervention
  • Governments intervene in a market economy in
    order to promote efficiency.

44
Role of Government
  • Market allocations are only efficient when
    conditions of perfect competition hold this
    means that no firm or consumer is large enough to
    affect input or output market prices.

45
con
  • When there are many small firms in a market,
    competition forces all firms to operate with
    lowest possible costs and prices.

46
Role of Government
  • Market allocations become inefficient when
    externalities occur. Externalities are the
    positive or negative effects on outside parties
    that production or consumption in an industry
    yields. For example,

47
Cont.
  • When people receive education, schools and
    students benefit, but so do others in the
    community who now have neighbors who are better
    educated.

48
Role of Government
  • Governments intervene in a market economy in
    order to promote equity, or fairness, in the
    distribution of resources and income.

49
Cont.
  • This is a difficult concept because there is no
    universal definition of fairness. Markets
    distribute goods and services to those who have
    the money to purchase them, not necessarily to
    those who need or deserve them the most.

50
Role of Government
  • Governments intervene in a market economy in
    order to promote macroeconomic growth and
    stability using monetary and fiscal policy.

51
Fiscal policies
  • Fiscal policies of government (the power to tax
    and spend) that try to affect the economic
    stability

52
Monetary policy
  • Includes
  • interest rate policies
  • Money creation and issuing
  • So It is (the power to adjust the money supply
    and interest rates)

53
The effect of M. F. policy
  • M. F. policy help to move an economy along a
    stable path, avoiding periods of excessive
    inflation and unemployment.
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