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Now that we have a good background on how the market system developed (see "The History of the Market System"), it is important to take a look at how the market system of today works. To do this, we will look at four important concepts—that of the factors of production, supply and demand, comparative advantage, and the circular flow.
The Resources Needed to Create Wealth
Let’s start things offwith a question. What is needed to create wealth? Within the marketplace, there are many resources that go into the production of goods and services. These resources can be grouped into four categories. These categories are land, labor, capital, and entrepreneurial ability.
The land category consists of not just land, but all natural resources. Labor is the work that is performed by man. Capitalis industrial machines and buildings, not financial capital (money is not capital by this definition). Finally, there is a special resource called entrepreneurial ability. This is where you come into play. It is the entrepreneur that organizes and arranges the use of land, labor, and capital to create an output demanded by the marketplace. It is the entrepreneur’s responsibility to decide on whatamounts of each resource to use and then use those resources efficiently to create a product or service that is valued higher by the marketplace than the collective value of the resource inputs. As Campbell R. McConnell and Stanley L. Brue say in Economics, "Both a sparkplug and a catalyst, the entrepreneur is at once the driving force behind production and the agent who combines the otherresources in what is hoped will be a profitable venture."
The Law All Entrepreneurs’ Must Understand
The second concept that is essential for all entrepreneurs to grasp is that of supply and demand. While you may have studied this in high school or college economics class, it is essential to have more than a classroom understanding of this principle.
Let’s begin with a simple demand graph.

Asthe demand curve illustrates, when the price of widgets are high, say $9, none are demanded. However, when the price is low, say $2, the marketplace demands many. As we can see from the following graph, the market would demand about 12 widgets when the price is $2.��

At a price of $2, twelve widgets will be bought. But would suppliers be willing to sell widgets for $2. Would they even make aprofit at this price level? Let’s look at the supply curve to see what amounts producers of widgets would be willing to sell at each price level.

The supply graph illustrates that as the price the market is willing to pay for widgets increases, widget suppliers are willing to produce a greater quantity of widgets. This makes sense. If the market would be willing to pay you more for your homemadecookies, you’d be willing to make more.
From the below graph, we can see that if the market was willing to pay $2, suppliers would be willing to produce 3 widgets.

This is a bit of a problem, however. If at $2 the market demands 12 widgets and only 3 are produced, they’ll be 9 people without widgets. There is a shortage in the marketplace. Widgets are scarce. Because those nine people knowthey will not get a widget unless they pay more, they bid up the price. A few of these nine people will not be willing to pay as much as they must to obtain a widget. A few of them will, however. This process eventually leads to an equilibrium price and quantity, where the suppliers produce exactly how many the market demands at a set price.
To determine this equilibrium price and quantity ofwidgets, let’s put the demand and the supply curves together on the same graph.

From this graph we can see that at a price of about $4.80 there will be 8 widgets demanded by the market place and 8 widgets supplied by producers. We have found the equilibrium price and level of output. This equilibrium point occurs where the supply and demand curves intersect.
Now, if demand increases, the...