LYCEUM OF THE PHILIPPINES UNIVERSITY

MANILA

College of Business Administration

MICROECONOMICS

Lecture 2: MODERN MIXED ECONOMY

➢ The economy of every country in the world is a mixed economy —a combination of private enterprise working
through the marketplace and government regulation, taxation, and programs
➢ THE MARKET MECHANISM
o A market is a mechanism through which buyers and sellers interact to determine prices and exchange goods,
services, and assets
▪ Markets are places where buyers and sellers interact, exchange goods and services or assets, and
determine prices
o A market economy is an elaborate mechanism for coordinating people, activities, and businesses through a
system of prices and markets.
▪ It is a communication device for pooling the knowledge and actions of billions of diverse individuals
▪ In a market economy, no single individual or organization is responsible for production,
consumption, distribution, or pricing
o The central role of markets is to determine the price of goods
▪ A price is the value of the good in terms of money
▪ Prices serve as signals to producers and consumers.
▪ Prices coordinate the decisions of producers and consumers in a market
• Higher prices tend to reduce consumer purchases and encourage production.
• Lower prices encourage consumption and discourage production.
o Market Equilibrium
▪ A market equilibrium represents a balance among all the different buyers and sellers
▪ The market finds the equilibrium price that simultaneously meets the desires of buyers and sellers.
• Too high a price would mean a glut of goods with too much output
• Too low a price would produce long lines in stores and a deficiency of goods
▪ Those prices for which buyers desire to buy exactly the quantity that sellers desire to sell yield an
equilibrium of supply and demand
o How Markets solve the three (3) economic problems?
▪ What goods and services will be produced is determined by the dollar votes of consumers in their
daily purchase decisions
• Firms are motivated by the desire to maximize profits.
o Firms abandon areas where they are losing profits
o Firms are lured by high profits into production of goods in high demand
▪ How things are produced is determined by the competition among different producers
• The best way for producers to meet price competition and maximize profits is to keep costs
at a minimum by adopting the most efficient methods of production
▪ For whom things are produced—who is consuming and how much—depends, in large part, on the
supply and demand in the markets for factors of production
• Factor markets determine wage rates, land rents, interest rates, and profits; such prices are
called factor prices.
▪ Forces affecting the market economy
• Tastes
o One fundamental determinant is the tastes of the population.
o These innate and acquired tastes—as expressed in the dollar votes of consumer
demands— direct the uses of society’s resources
• Technology
o The other major factor is the resources and technology available to a society
 o The economy’s resources limit the candidates for the dollar votes of consumers
o Circular Flow of Economic Life

▪ Provides an overview of how consumers and producers interact to determine prices and quantities
for both inputs and outputs
▪ Consumers/ Households:
• Buy goods and sell factors of production
• Use their income from the sale of labor and other inputs to buy goods from businesses
▪ Businesses:
• Sell goods and buy factors of production.
• Base their prices of goods on the costs of labor and property
▪ Prices in goods markets are set to balance consumer demand with business supply
▪ Prices in factor markets are set to balance household supply with business demand

Figure 1: Circular flow of Economic Life with the Three (3) Economic Problems
 ▪
Dollar votes of consumers interact with business supply in the product markets at top, helping to
determine what is produced
▪ Business demand for inputs meets the supply of labor and other inputs in the factor markets below,
determining wage, rent, and interest payments; incomes thus influence for whom goods are
delivered
▪ Business competition to buy factor inputs and sell goods most cheaply determines how goods are
produced
➢ TRADE, MONEY, AND CAPITAL
o An advanced economy is characterized by an elaborate network of trade that depends on specialization and
an intricate division of labor.
o Modern economies today make extensive use of money, which provides the yardstick for measuring
economic values and is the means of payment.
o Modern industrial technologies rest on the use of vast stocks of capital
▪ Capital leverages human labor into a much more efficient factor of production and allows
productivity many times greater than that possible in an earlier age
o Trade, Specialization, and Division of Labor
▪ Specialization and trade are the key to high living standards. By specializing, people can become
highly productive in a very narrow field of expertise.
• Specialization occurs when people and countries concentrate their efforts on a particular set
of tasks—it permits each person and country to use to best advantage the specifi c skills and
resources that are available.
• One of the facts of economic life is that, rather than have everyone do everything in a
mediocre way, it is better to establish a division of labor— dividing production into a
number of small specialized steps or tasks
▪ People can then trade their specialized goods for others’ products, vastly increasing the range and
quality of consumption and having the potential to raise everyone’s living standards.
• The enormous efficiency of specialization allows the intricate network of trade among
people and nations that we see today
o Money
▪ Money is the medium of exchange.
• It is the means of payment in the form of currency and checks used to buy things
• When everyone trusts and accepts money as payment for goods and debts, trade is facilitated
• Money acts as a matchmaker between buyers and sellers, effortlessly effecting little
marriages of mutual self-interest billions of times every day.
▪ Proper management of the financial system is one of the major issues for government
macroeconomic policy in all countries.
• Governments control the money supply through their central banks.
• If not properly managed, money can grow out of control and cause a hyperinflation, in
which prices increase very rapidly
• When that happens, people concentrate on spending their money quickly, before it loses its
value, rather than investing it for the future
o Capital
▪ Economic activity involves forgoing current consumption to increase our capital.
• Capital is a produced and durable input which is itself an output of the economy.
▪ Every time we invest—building a new factory or road, increasing the years or quality of education,
or increasing the stock of useful technical knowledge—we are enhancing the future productivity of
our economy and increasing future consumption.

END OF LECTURE

Sources:
Economics, Nineteenth Edition, Samuelson and Nordhaus
Various Websites