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Chapter 2: Economic Systems1. Answering three Economic Questions?2. The Free Market3. Centrally Planned Economics4. Mixed Economics
Government AllocationMarket Allocation
Free Market EconomyCommand, or Central Authority Economy
Mixed Economy
1. Answering three Economic Questions
• What goods and services should be produced?
• How should these goods and services be produced?
• Who consumes these goods and services?. . . Because resources are scarce
WHAT? HOW? WHO?
Goods and Services
Economic System• The structure of methods and principles a society
uses to produce and distribute goods and services• A way a society answers these questions defines its
economic system
Economic Goals and Societal Values
• Different societies answer the questions based on importance they attach to various economic goals
Economic Goals• Efficiency-Societies try to maximize their
resources• Freedom-the opportunity to make your own
choices• Security-”Safety net”-programs that protect
people who face unfavorable economic conditions
• Equity-How should we divide the pie?• Growth-innovation plays a huge role in
economic growth
Traditional Economies• An Economic system that relied on
habit, custom, or ritual to decide the three economic questions.
• There is little room for innovation or change in traditional economies
• Led to more modern economic systems
Three Economic Systems• Dominates the modern world• The free market economy (capitalism)• The centrally planned economy
(communism) (socialism)• The mixed economy –a little of both
Differing Systems• The United States
• Freedom• Security
• Efficiency• Equity• Growth
• The Soviet Union• Equity• Growth
• Security• Efficiency• Freedom
2. The Free Market• Economic Freedom -highly valued by
American Society• Markets -any arrangement that allows
buyers and sellers to exchange things• We are not producers of all our wants• Examples – fishing market, farmers
market, Sporting goods store, New York Stock Exchange Market
Why Markets Exist
• Specialization -concentration of the productive efforts of individuals and businesses on a limited number of activities
• Buying and Selling -sell what we produce and buy what we want
Free Market Economy• An economic system in which decisions
on the three key economic questions are based on voluntary exchange in markets
• Individuals make their own decisions• Capitalism -the capital that
entrepreneurs invest in businesses are vital
• Individuals and businesses own the factors of production
The United States Economy
• Free enterprise economy -private or corporate ownership of capital goods
• Government of the U.S. plays a major role in the economy
• “promote the general welfare”• Some people think that the government
intervenes too much in the economy• What do you think?
Households and Firms
• Household -person or group of people living in a single residence
• Firm - business or an organization that uses resources to produce a product, which it then sells
Factor and Product Markets
• Factor Market -the arena of exchange in which firms purchase the factors of productions from households
• Product Market -the arena of exchange in which households purchase goods and services from firms
Land CapitalLabor
Product Market
Circular Flow Model
Monetary Flow
Product Flow
Product Flow
Factor Market
The Self-Regulating Nature of the Marketplace
• Self Interest -an individual’s own personal gain
• Incentive -the hope of reward or fear of penalty that encourages a person to behave in a certain way
• Competition -the struggle among producers for the dollars of consumers
• The Invisible hand-Adam Smith-the self regulating nature of the market place
• “Give me that which I want, and you shall have this which you want . . . . It is in this manner that we obtain from one another the far greater part of those good [services] which we stand in need of. It is not from the benevolence of the butcher, the brewer, or that baker that we expect our dinner, but from their regard to their own interest.” –Adam Smith, The Wealth of Nations
Adam Smith
Advantages of the Free Market
• Efficiency -produce what consumers want
• Freedom -work where you want, produce what you want, consume what you want
• Growth -innovations• Consumer Sovereignty - having the
power to decide
3. Centrally Planned Economics
• How Central Planning Works • Government makes all the decisions on
three questions (command economy)• Government owns all factors of
production• Direct contrast to free market
structure
Socialism and Communism• Socialism – range of economic and social systems based on belief
that wealth should be distributed evenly throughout a society• Communism- political system in which government owns all
resources and means of production and makes all economic decisions
• “Capitalist production . . . Develops technology and the combining together of various processes . . . Only by sapping the originalsources of all wealth- the soil and the laborer.” – Karl Marx, The Communist Manifesto
• All my hard work and all the moneyends up in the hands of capitalists
Authoritarian
• Form of government that limits individual freedoms and requires strict obedience from its citizens
• Communist governments are always authoritarian
Three Communist Economies• The Soviet Union -1917-Bolshevik Revolution-
Joseph Stalin-broke up in 1991• China - 1949 to late 1970’s-government
planners controlled all aspects of Chinese society; adopted some free market
• Cuba – Fidel Castro – 1959 – Cuban Revolution
Disadvantages of Centrally Planned Economies
• Efficiency -no incentive to work hard• Freedom -discourages competition • Growth -no innovation no growth• Equity -human intuition prohibits equity
The need to satisfy all wants and needs
4 Mixed Economies
• Reasons for Government Involvement • Laissez-faire -government generally
should not intervene in the marketplace• Private Property -property owned by
individuals not the government• Mixed economy -market-based
economics in which government is involved to some extent
Government in Market
• Factor Market -government instead of individual owns factors of productionProduct Market -government purchases all goods and services and provides them the public
Greatest Expenditure in U.S. Government – Social Security