here we [Music] go hello everyone how are we doing today today's lesson is going to focus on a basic economic concept that is fundamental to our study of market economics at this point in your course you have probably already learned the definition of a market a market is simply a place where buyers and sell sellers meet to engage in mutually beneficial exchanges with one another in a market economy there are two fundamental types of markets that must exist in order for mutually beneficial exchanges to occur a market economy is one in which households and firms engage in exchanges in both resource markets and in product markets that benefit both the firms and the households themselves so this video Lesson is going to illustrate r at the flow of goods Services land labor capital and money in a market economy between households and firms and seek to understand how individuals stand to benefit from the trades that take place in a market economy so let's start off with a couple of definitions here first let's look at the household side of our graph we see that households possess three scarce resources now you'll recall from a previous lesson that something is scarce when it is both desired and limited in Supply in the case of land labor and capital these are all resources that exist in finite amounts in the world land resources are those that can be used to grow crops to mine minerals to catch fish to log forests all of the land resources these are the natural resources that are used to produce goods and services that we like to consume labor of course that's just human resources this is any input into the production of a good or service that involves workers we're talking about Factory workers we're talking about high-skilled workers educated people and uneducated anybody who adds to the production of something is considered labor Capital this is the technology that is used to produce Goods I put a computer here because I'm a teacher and in fact in the production of this very video Lesson the capital resource that I'm using is a computer capital resources also include things like Factory equipment uh tractors for Farmers any sort of technology that is used in the production of goods households are the owners of these scarce resources the land is held by either private individuals or households through the public sector labor of course this is workers that live at home and go to work at a factory or in an office every day and capital we provide Capital to the market economy through our savings of money that will be explained a little bit later on when it comes to how firms acquire capital in the production of goods and services so there you see one side of the circular flow model of a market economy we see that households possess three productive resources land labor and capital we must exchange these resources in the resource market so the first flow that we're going to illustrate in our circular flow is the flow of resources from households two firms in the resource market now why do firms need resources what are firms going to do with the resources that they get from households in the resource Market as we can see in the left side of our circular flow model firms are essentially entities that are established by entrepreneurs or individuals from households that wish to start a business in order to make some money now entrepreneurs and the firms that they run need resources in order to make money so firms will wish to acquire resources from households so that they can put these resources to use to make goods and services that they can sell back to households so the resource Market is where the entire circular flow begins firms are the buyers in a resource Market firms buy resources households sell resources and the resources that are being bought and sold are land labor and capital so in the circular flow we should see resources flow from households to the resource Market to firms so that they can be employed in the production of goods and services we also learned in a previous lesson that in a world of scarce resources there is nothing free therefore firms must give something up in order to acquire these three scarce resources and that's where money comes into play as we can see here money is is what makes a circular flow function firms or the entrepreneurs that start the firms must have money at their disposal in order to begin a business with some money firms can exchange in the resource market for the land labor and capital they need so in the other direction in our circular flow model we're going to see money flowing from firms to households money of course is what makes the circular flow function households are providing land labor and capital in the resource Market which are the factors of production these are the things that firms need in order to make goods and services but in exchange for these things firms are going to pay money to households the money firms pay households in the resource Market is income for households for our labor households earn wages for our land we earn rent and for our Capital we earn interest these money incomes are the incentive that households have to provide land labor and capital to firms in the resource market now why do we care about money anybody who has ever been shopping Knows Why money is important money is what allows households to acquire the goods and services that they demand in the product market so now we've got half of our circular flow model made we see that households are providing resources in the form of land labor and capital to entrepreneurs to the firms in the economy in the resource Market these act as factors of production for firms which they can use to make goods and services which they can then sell us in the product Market but nothing's free in a market economy so of course money has to flow in the other direction money is Flowing from firms to households in the resource market now where are we in the model we see that money has changed hands in the resource Market households have earned money but what good is money if not to consume with so what are households going to consume this brings us to the product market with the factors of production with the land labor and capital that firms have acquired in the resource Market they can begin manufacturing or producing goods and services so we should start to see production occur in the market economy so now firms have lots of goods and services which they produced using the resources acquired in the resource Market of course the reason for the production that firms have undertaken is to sell a market economy is all about selling households sell resources in the resource market and firms sell goods and services in the product market so we should start to see these goods and services flow counterclockwise in the product Market towards households and that's exactly what should happen next the purple arrows represent the flow of goods services and resources so in product markets firms are the suppliers and households are the demanders so firms sell and households buy products of course nothing is free in a market economy in order to acquire these goods and services that they so demand we can see Goods flowing to households but that doesn't come free money must change hands money must flow close clockwise from households to firms so that firms are earning the profits that they so desperately seek and that of course is the orange arrow in our circular flow model we will see money flow from households to firms in the product market so it's a little bit difficult to see here but what we should notice is that there are arrows indicating the flow of money land labor capital capital and goods and services in our circular flow model notice that in this case money is always flowing counterclockwise and resources goods and services are always flowing clockwise the goal of firms and households in this model of the market economy are very clear firms are profit Seekers so the goal of firms is to maximize profits to do this firms must sell their goods and services for more than they spent on resources that's the definition of a profit essentially it's when a firm's total revenues are greater than its total costs and other words it's sold for more than it costs to produce and the goals of households what is the goal of a household here is the goal of households just to make money that's not at all the case in fact money is only a medium of Exchange in a market economy the goal of households is to maximize utility you may be unfamiliar with this word utility but it has a simple definition in economics and that is happiness in a market economy we're going to simplify things dramatically here we're going to say that happiness is achieved through consumption of goods and services so recall a market is a place where buyers and sellers meet to engage in mutually beneficial exchanges look again at our resource Market how do households benefit from providing providing land labor and capital to firms in the resource Market well they do so because they are earning money incomes households of course are earning incomes in the form of wages rents interests and profits for the entrepreneurs Who start the businesses with these money incomes households can ultimately acquire the goods and services that they demand in the product Market the goal of any household is to earn a high enough money income to enjoy a level of consumption of goods and servic that improves the family standard of living now let's look at the product Market firms recall are seeking profits the goal of firms should be to end up with more money than they started with firms sell their goods and services that they produced using the resources acquired in the resource Market back to households hopefully for a profit earning greater revenues than the firms incurred in costs so the beneficial nature of the market econ e omy exists in so far as that households willingly Supply their resources land labor and capital to firms with the ultimate goal of earning money incomes which can be used to buy goods and services which provide households with utility or happiness firms on the other hand willingly provide goods and services to households in exchange for the money that they previously had paid those households in the resource markets the goals are to maximize profits and to maximize utility this is the essential nature of a market economy without these incentives without these goals of households and firms a market economy would simply not function and resource allocation would have to be undertaken by another mechanism alog together such as government control or a command system of some sort that wraps up this lesson we will do future lessons on the market economy including a macroeconomic model which includes not just households and firms but also the government and the banking sector