Chapter 2(1)

Chapter 2THE MODERN MIXED ECONOMY

PROF JEAN-PIERRE MULUMBA 2

About This Chapter What is a market?

Role of the market in the modern nations

Market mechanisms

How market solve the Three Fundamental Questions

Role of government in market economy


Learning Objectives After studying this chapter students should be able to:

◦ Define a Market.�◦ Describe a modern advanced economy.�◦ Describe the economic role of Modern Government in different economic organizations.�◦ Sketch the market failures and assorted government responses nowadays.�◦ Differentiate between various economic policies.�


Introduction Medieval Era, the aristocracy and town guilds directed much of the economic activity.

The 19th Century, the age of ”laissez-faire”, the era of the queen market.

In the 20th Century, some economies adopted the socialism◦ Government control on the economic activities◦ Around 90s communists countries adopted the market rule

Modern economies are mixed economies◦ Combination of marketplace decision and government regulation


What Is A Market? A market is a mechanism for coordinating activities through prices and markets.

◦ Allowing buyers and sellers to set price and exchange goods or services.

It is a communication device for pooling actions of diverse individuals. . ◦ It may be centralized. ◦ It may be decentralized, as is the case for most workers. ◦ it may exist only electronically’


What Is A Market? (1) In a market system, everything has a price.

Prices are terms on which we exchange different commodities.

It is the value of the good in terms of money. ◦ They serve as signals to producers and consumers.

There is no chaos but economic order.


Market Equilibrium When they balance all the forces operating on the economy

It is a balance among all the different buyers and sellers ◦ Finding the equilibrium price

◦ That simultaneously meets the desires of buyers and sellers ◦ Yielding an equilibrium of supply and demand


How Markets Solve the Three Economic Problems?

By matching sellers and buyers

And simultaneously, solves the three problems of what, how and for whom.

The what problem is solved by ◦ Dollar votes of consumers, and ◦ Desire to maximize profits for firms.

How problem is determined by the competition among producers

For whom question depends on the supply and demand for factors of production ◦ Wage rates, interest rates, and profits


• Who Are The Rulers In A Market Economy?

Forces affecting the market economy are tastes and technology ◦ Consumers with their tastes and dollar votes ◦ Producers with the available technology and resources

The market system deals out profits and losses ◦ To induce firms to produce desired goods efficiently


The Circular Flow Model Market economy presents the following picture: The Circular Flow Model

◦ An overview of consumers and producers interactions to set prices and quantities

The model: ◦ Two economic agents:

◦ Households ◦ Firms, businesses, producers

◦ Two markets: ◦ Products Market ◦ Factors of production Market

◦ Assumption: households own all the factors of production


Economic Agents A household is a domestic unit of a family who live together share their income & consumption.

A firm is a business enterprise that produces goods and services for sale.

Firms sell goods and services that they produce to households in Markets for Products.

Businesses buy resources they need to use—factors of production—in Factor Markets.


Circular Flow Diagram


The Functioning of Market Economy: The Invisible Hand

Adam Smith:

The Invisible Hand: the way the market economy organizes the supply and demand. ◦ Private interest can lead to public gain in a well-functioning market mechanism ◦ Then, governments interference in economy is almost injurious �◦ But when there are market failures government intervention is desirable


Trade, Money and Capital Distinguishing traits of a modern economy:

◦ Elaborate network of trade based on specialization and division of labor ◦ Extensive use of money ◦ Use of vast stocks of capital


Trade, Specialization and Division of Labor

The trade network depends on specialization and the division of labor

Specialization: effort limitation on special productions, or on particular sector of activity ◦ Division of labor: dividing production into a number of specialized steps or tasks ◦ Specialization and trade have produced the globalization

◦ High integration of nations economies


Money: The Lubricant Of Exchanges

Means of payment in the form of currency and checks ◦ Used when we buy goods and services ◦ Lubricant that facilitates exchanges

◦ Everyone accept them: medium of exchanges

Governments control the money circulation ◦ Money supply is major issue of macroeconomics

◦ Inflation ◦ Deflation


Capital One of the three traditional factors of production

It is the most characteristic resource of advanced industrial economy

It is: ◦ A produced factor of production, ◦ A durable input ◦ An output of the economy

Obtained by abstaining from present consumption

In a market economy, it is privately owned

Gives it is name to the capitalist system


The Visible Hand of Government(1) The invisible hand is an idealized functioning of the economy.

The economic imperfections lead to many ills.

That's why no government keeps its hands off the economy. ◦ In response to the flaws in the market mechanism ◦ Beside the typical government activities ◦ The socially useful ventures ◦ And regulation of some businesses


The Visible Hand of Government(2) Government perform their functions by

◦ Requiring people to pay taxes ◦ Requiring people to obey regulations ◦ Requiring people to consume certain collective good and service

Governments have three economic functions in a market economy: ◦ Increase economic efficiency ◦ Promote equity ◦ Foster macroeconomic stability and growth


Efficiency Of The System The invisible-hand doctrine applies to perfectly competitive markets

◦ A market in which no agent can affect the market price.

Perfectly competitive markets produce an efficient allocation of resources, ◦ The economy is on its production-possibility frontier.

The three important ways to imperfect competition are: ◦ Monopolies ◦ Externalities ◦ Public goods


Government: Increases The Efficiency Of The System

Government increases efficiency by this kind of actions

Government promotes competition by fighting imperfect competition ◦ Monopoly is the extreme case ◦ Use regulation in concerned sectors

◦ Anti-trust laws ◦ Solution: market opening to many competitors.


Government: Increases The Efficiency Of The System (1)

Government curbs externalities ◦ Spillovers which involve involuntary imposition of costs or benefits ◦ Activity that helps or hurt people outside the marketplace ◦ Negative externalities are nowadays major threats ◦ Government regulations: solution to control externalities


Government: Increases The Efficiency Of The System (2)

Government provides public goods ◦ Commodities that can be enjoyed by everyone ◦ Commodities that no one can be excluded ◦ Commodities which the cost of extending the service to an additional person is zero ◦ Governments use revenues from taxation to provide them ◦ Taxes are also used to finance income-distribution programs ◦ They are levied on

◦ personal and corporate incomes, ◦ on wages, ◦ on sales of consumer goods, etc


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Chapter 2(1)

Economy & Finance