Chapter 2  can be divided into two major parts.  The first involves the major characteristics of the typical market economic system, and the second deals with how a market economy answers the “fundamental questions.”

Professor McConnell identifies eight(8) notable characteristics of a market system.  For our purposes, we will focus on five.

   1.                 Private property

2.                 Competition

3.                 Markets and Prices

4.                 Active but Limited Government

    In the second part of the chapter, McConnell discusses how the market system answers the Five Fundamental Questions.  We will focus on the first three.  You should be able to briefly explain how the market system answers each question.

      1.                 What will be produced?  The answer is that those goods that are  profitable to produce will be produced.    Focus on the idea of consumer sovereignty on page 34.

2.                 How will goods and services be produced?  The answer to this question is that firms will choose to produce using the “least-cost” method of production.   

3.                 Who will gets the goods?   The answer is that those who are will and able to pay the market price will get the goods.  Those who are not willing and able to pay will not get them.  We call this the “rationing function of price.”   

                 Read carefully page 37 which deals with Adam Smith and the “invisible hand.”

          Finally, at the end of Chapter 2, the author introduces us to what is known as the "simple" circular flow model or diagram.  The purpose of the model is to describe the real and money flows in a typical market economic system.  Excluding government for the time being, we can divide all economic decision makers into two groups; businesses and households.  The households are the owners of the resources or factors of production and the consumers of goods and services. Businesses are the users of the factors of production and the  providers of goods and services.

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