Consumer Sovereignty
Consumers "rule": the mix of output in any free market system is dictated ultimately by the tastes and preferences of consumers. Consumers "vote" by buying or not buying. Goods which get enough dollar votes to cover their opportunity cost are produced; others are not. Output of a good rises and falls in response to consumer demands; no central directive or plan is necessary.

Free Enterprise

Individuals seeking profits are free to start new businesses Individual producers, large or small, must figure out how to organize the actual production-- what resources to hire in the resource or factor market and how to coordinate them. Those that operate efficiently and produce a good or service in demand will succeed Those that are poorly run will fail as more efficient producers take business away from them.

Distribution of Output

Household income is determined in the factor market. It depends on the resources each household owns and how valuable these are to producers (the dollar votes by firms for those resources) The market allocates goods to those households willing to pay the most. Households which do not value a good very highly will voluntarily drop out of the market as the price rises and substitute other goods. The market, therefore, allocates good to people dependng on their income and willingness to pay.

Social goals

Technical efficiency-- goods are produced using the fewest possible resources (no waste) Allocative efficiency-- gains from trade are maximized. There are no addiitional transactions which would benefit someone without making someone else worse off. Resources aren't wasted producing items of low value to consumers. Distribution of goods is equitable or "fair." The economy is stable and growing steadily so that well-being will improve over time.

Operation of Product Markets
Buyers choose which combination of goods and services will maximize the satisfaction they get from their limited income. Sellers choose how much to produce and offer for sale in order to get the most profit (their income). The interaction of buyer and sellers determines the price and quantity of goods sold and hence the allocation of resources

Buyer behavior

Consumers must choose among a variety of goods which provide satisfaction. Consumers maximize satisfaction by applying the marginal principle: consumer more as long as the marginal benefit of an additional unit is greater than the marginal cost. If one sandwich costs $1 and a container of yogurt costs $0.50, then the marginal opportunity cost of a sandwich is 2 containers of yogurt. If the sandwich provides more satisfaction than 2 containers of yogurt (if, say, the satisfaction equals that from 4 containers of yogurt), then the consumer is better off buying a sandwich.

Consumers benefit
The amount consumers are willing to pay for a good depends on how much satisfaction they get from one unit relative to the satisfaction from the best alternative. If one unit of a good (a sandwich) provides four times the satisfaction of the alternative (container of yogurt), consumers would be willing to sacrifice four units of the alternative (yogurt) or to pay four times the dollar price of the alternative (4 x $0.50 = $2) to get the good. If they get the good for a smaller sacrifice (lower price) than the marginal benefit (as measured by what they would have been willing to pay for an additional unit), they gain by the exchange.

Diminishing Marginal Utility

Economists call the marginal benefit of a good its marginal utility. The marginal utility is the change in a person's satisfaction from having one additional unit of a good. The law of diminishing marginal utility says that as consumption of a particular good increases, the marginal utility decreases. As a person increases consumption of a good, the marginal benefit declines; at some point the marginal benefit falls below the marginal cost and the consumer does not want to purchase additional units.

Sellers behavior
Firms maximize profits by applying the marginal principle: produce more as long as the marginal benefit (additional revenue) is greater than the marginal cost of producing. To produce a unit of a good, firms give up the opportunity to do something else with resources. The value of the alternatives he could have produced is the opportunity cost of producing the good in question. The dairy that produced the container of yogurt could have used the milk to make 2 oz. of sour cream. The marginal cost of a container of yogurt is 2 oz. of sour cream. If 2 oz. of sour cream would have sold for $0.35, the opportuntiy cost of the container of yogurt is 0.35. A firm will only produce and sell if it gets at least as much as it could by selling the alternative. If the firm gets more than the opportunity cost of producing a unit of the good, the owners are better off (have higher income). The dairy will only produce and sell yogurt if it can get at least $0.35 for the yogurt. If it gets more, it earns a profit for the owners.