Fundamental Questions

1. In a market system, who decides what goods and services are produced and how they are produced, and who obtains the goods and services that are produced?

2. What is a household, and what is household income and spending?

3. What is a business and what is business spending?

4. How does the international sector affect the economy?

5. How do the three private sectors-households, businesses, and the international sector-interact in the economy?

Teaching Objectives

The primary purpose of this chapter is to outline the major private sectors of the economy and their spending.

The unique feature of this chapter is its discussion of the coordinating role of the market in the private economy. The roles of households, businesses, and the international sector are also presented.

In this chapter you will want to emphasize the role of the entrepreneur in the market economy, the important questions that are answered by the market system, and how the sectors of the private economy are linked together using the circular flow model.

Key Term Review

consumer sovereignty
private sector
public sector
household
consumption
business firm
sole proprietorship
partnership
corporation
multinational business
investment
imports
exports
trade surplus
trade deficit
net exports
financial intermediaries
circular flow diagram

Lecture Outline and Teaching Strategies

1. The Market System

1.a. Consumer sovereignty: Through their buying decisions, consumers determine what the market system will produce.

Teaching Strategy: Use the example of Coca-Cola's attempt to reformulate its recipe to make the point that consumers call the shots in the market system.

1.b. Profit and the allocation of resources: Resources will be used in endeavors that generate profits to the producer (which derive from meeting consumer wants).

Teaching Strategy: Demonstrate sequentially through the Pizza Hut example how increased home delivery of pizza resulted from the increase in demand for home delivery and the decrease in demand for restaurant meals.

1.c. The flow of resources: Profit incentives ensure that resources flow to their most productive use.

Teaching Strategy: Point out that people who own resources will try to find uses for their resources that yield the highest possible return. A good example is how people allocate their financial resources in financial markets.

1.d. The determination of income: Income is determined according to the returns that people receive from their resources.

Teaching Strategy: Differences in incomes are due to the relative scarcity of the resources that individuals hold. You can use this idea to explain how Roger Clemens and Madonna earn millions of dollars annually.

2. Households

The household, one of the basic units in economics, consists of persons of any relationship who share a unit of housing.

2.a. Number of households and household income

Teaching Strategy: A family like the Cleavers (of "Leave It to Beaver") is not representative of the norm in the U.S. economy. Only 16 percent of all households have a husband, a wife, and two children.

2.b. Household spending: Known as consumption, household spending accounts for about two-thirds of total spending in the U.S. economy.

3. Business Firms

3.a. Forms of business organizations: Firms are organized as sole proprietorships, partnerships, or corporations.

Teaching Strategy: It is useful to think of the forms of business organization in terms of the distribution of business profits or losses and of liabilities to the owners.

3.b. Business statistics: The United States has far more proprietorships than partnerships or corporations.

3.c. Firms around the world: Big business is not just an American phenomenon.

3.d. Entrepreneurial ability: Entrepreneurs are successful only to the extent that they satisfy a consumer demand.

Teaching Strategy: Be sure to emphasize the role that risk plays in entrepreneurial activity.

3.e. Business spending: Business expenditures on plant and equipment is referred to as investment.

4. The International Sector

4.a. Types of countries

4.a.1. The industrial countries

4.a.2. The developing countries

4.b. International sector spending: The United States has run a trade deficit since 1983.

Teaching Strategy: You will surely surprise many of your students by pointing out the large volume of U.S. exports to Japan. Ask your students if they believe that these data are consistent with all the media stories about strong Japanese trade barriers.

5. Linking the Sectors

5.a. Households and firms: Households own all the basic resources in the economy.

Teaching Strategy: Make it clear that a business firm is a legal construct and thus cannot own anything. Only people own things.

Teaching Strategy: Take some time to present the circular flow model as fully as possible. Work through the effects of changes in spending from various sectors. This will pay off when you present the income expenditure model later.

5.b. Households, firms, and the international sector: Spending may be for foreign as well as domestic goods; production may be for foreign as well as domestic consumption.