Understanding Economic Systems: Basics and Market Operations
Understanding Economic Systems
Economics Basics: An economic system is how individuals are organized in a society to solve their basic economic problems:
- What to produce?
- How to produce?
- For whom to produce?
The economic system is the set of relations, techniques, and characteristics of the institutional and economic organization of a society.
Economic Doctrines and Economic Systems
An economic doctrine is the set of ideas or opinions held by an important group of economists, such as Smith, Marx, and Keynes.
- Liberalism: The absolute predominance mainly provides a markup. Smith was the founder of economic liberalism. It is based on the operation of the market.
- Marxism: Represents the opposite of liberalism. Smith was the prophet of industrial revolution development and capitalism; Marx was a deeper critic.
Operation of the Market Economy
The market economy rests on a set of markets where goods are bought and sold (supply and demand) and factors of production are bought and sold (supply and demand of factors of production). This is how the three questions are answered by the economic system.
A market is a place or social institution where goods and factors of production are exchanged freely.
Key Aspects:
- The producers offer those goods that are profitable to them, based on supply and demand.
- Consumers can choose what to buy, trying to maximize their total satisfaction.
- Individuals can rent or buy factors of production and become producers, delivering goods to the market.
- Market demand or changes in the rating of goods cause changes in the cost of carrying goods, and prices manage to balance supply and demand.
Advantages:
- Individuals may choose to produce and consume according to their preferences or availability.
- The pricing system allows shortages and surpluses of goods not to last.
- The state does not intervene in production decisions.
- Individuals have incentives to act in a productive way. If products launched are what consumers want, they can reap significant benefits.
Disadvantages:
- Market errors hinder the operation of the market.
- Large income differences pose problems of equity.
- Advertising can be used to manipulate consumers.
- Market economies tend to be unstable.
Law of Decreasing Yield
Under this law, from a certain level of production, as units are added of variable factors (labor) to fixed factors (capital), the quantity of product obtained increases by smaller increments.
This occurs if the marginal productivity of labor is decreasing. This indicates that each worker contributes less to production than the one before. Therefore, the law of decreasing yield is reflected in the decreasing section of the marginal product.
Profit Maximization
The level of production achieved in the maximization of profit is that level where the difference between total revenue (TR) and total cost (TC) is maximized. The company will produce the quantity that maximizes profit, in which the positive difference between total income and total cost is maximal. In this situation, marginal revenue (MR) is equal to marginal cost (MC). In graphical terms, MC is calculated by the slope of TC, and MR is the slope of TR. Profit is maximized when these two slopes are equal.