Markets and Governments in a

Modern Economy
Chapter 2
Samuelson, Nordhaus 18e

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Markets & Government in a

Modern Economy
What is a Market?
A market is a mechanism through which buyers and
sellers interact to determine prices and exchange
goods and services.
Market System and Price
Prices serve as signals to producers and consumers.

Prices coordinate the decisions of producers and

consumers in a market
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Markets & Government in a

Modern Economy
What is a Market? Cont.
How Markets Solve the Problem of the Three
Economic Problems?
By matching sellers and buyers (supply and
demand) in each market, a market economy
simultaneously solves the three problems of what,
how and for whom.

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Markets & Government in a

Modern Economy
The Circular Flow of
Economic Activity
Here goods and services flow
clockwise: Labor services
supplied by households flow
to firms, and goods and
services produced by firms
flow to households.
Payment (usually money)
flows in the opposite
(counterclockwise) direction:
Payment for goods and
services flows from
households to firms, and
payment for labor services
flows from firms to
households.

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Markets & Government in a

Modern Economy
What is a Market? Cont.

Labor Market: The input/factor market in which

households supply work for wages to firms that demand
labor.
Capital Market: The input/factor market in which
households supply their savings, for interest or for claims
to future profits, to firms that demand funds to buy capital
goods.
Land Market: The input/factor market in which
households supply land or other real property in
exchange for rent.
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Chapter 2
Figure 2-1

The Market System Relies on Supply &

Demand to Solve the Trio of Economic
Problems

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Markets & Government in a

Modern Economy
Trade, Money and Capital
Trade, Specialization, and Division of Labor
Money: The Lubricant of Exchange
Capital

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Markets & Government in a

Modern Economy
Trade, Money and Capital (cont.)
Trade, Specialization, and Division of Labor
As individuals and countries become increasingly
specialized, they tend to concentrate on particular
commodities and trade their surplus output for
goods produced by others.

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Markets & Government in a

Modern Economy
Trade, Money and Capital (cont.)
Money: The Lubricant of Exchange
Money is the universally acceptable medium of
exchange.

Syed Arshad Hussain Lecturer

Markets & Government in a

Modern Economy
Trade, Money and Capital (cont.)
Capital
Inputs such as machinery, structures, and
inventories of goods in process.

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Markets & Government in a

Modern Economy
The Economic Role of Government
Governments have three main economic
functions in a market economy.
Efficiency
Imperfect Competition
Externalities
Public Goods

Equity
Macroeconomic Growth
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Markets & Government in a

Modern Economy
The Economic Role of Government
Efficiency
Governments increase efficiency by promoting
competition, curbing externalities like pollution,
and providing public goods.

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Markets & Government in a

Modern Economy
The Economic Role of Government
Efficiency (cont.)
Perfect Competition
A market in which no firm or consumer is large enough to
affect the market price.

Imperfect Competition
When a buyer or seller can affect a goods price.

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Markets & Government in a

Modern Economy
The Economic Role of Government
Efficiency (cont.)
Externalities
Externalities (or spillover effects) occur when firms or
people impose cost or benefits on others outside the
marketplace.

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Markets & Government in a

Modern Economy
The Economic Role of Government
Efficiency (cont.)
Public Goods
Commodities or services which can be enjoyed by
everyone and from which no one can be excluded.

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Markets & Government in a

Modern Economy
The Economic Role of Government
Equity (fairness)
Governments promote equity by using tax and
expenditure programs to redistribute income
toward particular groups.

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Markets & Government in a

Modern Economy
The Economic Role of Government
Macroeconomic Stability and Growth
Governments use the tools of fiscal and monetary
policies to encourage economic growth.

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Markets & Government in a

Modern Economy

Chapter 2
Table 2-1

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