Understanding Economics - Chapter 2

ECONOMIC SYSTEMS AND DECISION

MAKING

Chapter 2, Lesson 1 ECONOMIC SYSTEMS

Traditional Market Command

Mixed

! Economic System – organized way a society uses its resources to provide for the wants and needs of its people ! This is how it answers the three questions, WHAT, HOW and

FOR WHOM.

ECONOMIC SYSTEMS

!  Traditional economy – economic system in which the allocation of scarce resources is the result of ritual, habit or custom. !  People’s roles are defined by the customs of their elders and

ancestors. !  Job or roles are often handed down generation to generation. ! Decisions are made according to historical pattern. ! Often have a tradition of sharing and can survive as long as there

are skilled hunters and farmers !  The three questions of WHAT, HOW and FOR WHOM are answered

according to tradition – things are done they way they were always done.

!  Examples: African Mbuti, Australian Aborigines or Inuit of North America

TRADITIONAL ECONOMY

Advantages

! Roles are clearly defined.

! Family and community ties are strong.

Disadvantages ! Change and new ideas are

discouraged, so methods of production are inefficient. !  Stagnation – lack of progress

! Choice of consumer goods is limited.

!  You are not allowed to choose a role different from the one given to you by tradition.

!  Lower standard of l iving

TRADITIONAL ECONOMY

!  Command economy – economic system characterized by a central authority (government) that makes most of the major economic decisions. !  A central authority or government makes the decisions WHAT, HOW

and FOR WHOM to produce. !  This central authority can be a king, dictator, president or tribal leader

or the government led by them. !  Characterized by socialism – economic system in which government

owns factors of production and has a role in determining what and how goods are produced.

!  In a “pure” command economy, the government makes ALL decisions about WHAT, HOW and FOR WHOM.

!  Most command economies severely limit private property rights. (People cannot own homes and businesses.)

!  Some governments are generous with their country’s wealth and share it with the people. Some governments hoard the wealth for the leader, and the people are left poor.

COMMAND ECONOMY

! Command economy – economic system characterized by a central authority (government) that makes most of the major economic decisions. ! Decisions made by the government are not necessarily made for

the people. !  Examples of “pure” command economies: Cuba, North Korea,

Venezuela !  There are few examples of “pure” command economies as many of

these countries have transitioned to capitalist economies. (Ex: Soviet Union)

COMMAND ECONOMY

! Advantages: ! Can change direction quickly

!  USSR went from agricultural to industrial in a few decades in the early 1900s.

! Governments may provide goods and services some people cannot otherwise afford. !  Universal healthcare, free education

!  Equality for the population !  The majority of the population has the same income and same standard

of living – this is called income equality.

COMMAND ECONOMY

!  Disadvantages: !  Leaders provide for themselves at the expense of the population.

!  Only government officials are in the upper class. !  There are many people who are poor and may have to go without

necessities. !  North Korea has high spending for defense while people go without food.

!  Individuals do not have the freedom to choose !  Even if you don’t want national healthcare services, you have to pay for it

anyway. !  You may be told where to live or what type of job to have. !  Media is free but controlled by the government. People only have access to

propaganda. !  Low quality goods

!  Workers are given quotas as motivation, not quality. !  Large decision making bureaucracies

!  This slows decision making and raises the costs of production. !  Decision makers are motivated by politics, not economics.

COMMAND ECONOMY

!  Disadvantages : !  Little motivation to work hard

!  Workers are paid whatever the government decides and cannot get ahead by working harder or showing inventiveness.

!  Even a doctor may not make much more than a factory worker – all wages are uniform.

!  This diminishes the motivation for people to become educated or learn new skills.

!  Decision making bureaucracies lack the flexibility to handle problems in a timely fashion. !  As a result, they tend to go from crisis or crisis or even to collapse altogether. !  Cannot react to global economic issues such as agricultural shortages or

changes in prices for natural resources. !  Command economies stay relatively small because they have a hard time

making the decisions necessary for growth and change to take place. !  When an economy reaches a larger size, such as the former Soviet Union, it is

so hard to coordinate decisions that the country can collapse without outside pressure.

!  Limited consumer choices !  Individuals are not free to start new businesses.

!  TINSTAAFL !  Countries with free universal health care and free education (such as Denmark,

Norway and Sweden) have very high taxes to pay for these services.

COMMAND ECONOMY

!  Market – meeting place or arrangement through which buyers and sellers interact to determine the price and quantity of goods and services.

!  Market economy – economic system where WHAT, HOW and FOR WHOM decisions are made by individuals acting in their own self-interest !  Characterized by freedom

!  People decide WHAT is produced by what they choose to buy. !  Businesses are free to decide HOW to produce. !  Individuals decide FOR WHOM by what they choose to buy.

!  Characterized by private ownership of resources !  Characterized as capitalism – economic system in which private

citizens own and control the factors of production in order to generate profits.

!  The role of the government is limited. !  Many of the most prosperous economies in the world are based on

markets and capitalism: Australia, Canada, U.S., Great Britain, South Korea, Japan

MARKET ECONOMY

!  Advantages: !  Freedom

!  Individuals are free to buy what they want, get any education they want, have any job they want, start any business they want.

!  Businesses are free to produce what they want, hire who they want and produce the way they want to produce.

!  The economy adjusts gradually to change over time. !  Example: As fuel prices change, we change what types of vehicles we want

to buy and businesses change what types of vehicles they produce. !  Minimal government interference in the economy

!  Except for some regulation, government does not interfere in transactions between buyers and sellers.

!  Decision-making is decentralized !  We, as individuals, make decisions about what the economy produces by

what we choose to spend our money on. Individuals control the economy, not government.

MARKET ECONOMY

!  Advantages: !  There is a wide variety of goods and services consumers can choose

from. !  If a product can be imagined, someone can build a business to produce it,

and it becomes available to be bought. !  There is a high level of consumer satisfaction.

!  Consumers can always find the products they want because such a wide variety of products are available.

!  Production is more efficient. !  Because workers can be rewarded for hard work and inventiveness, they are

motivated to find better and less expensive ways to produce products. !  Private ownership of property

!  Property lasts longer and is better maintained because the individuals that own it care for it.

!  Property that is government owned or collectively owned is not cared for by any person.

MARKET ECONOMY

! Disadvantages: !  In a pure market economy, you must work to survive.

!  Individuals who cannot or do not work have no way to earn income. !  A market economy may not provide enough of some basic goods

and services. !  Private markets do not supply all of the roads and libraries people would

like to have. !  Private markets do not supply free education and free healthcare.

! Market uncertainty !  Will a new business come along and take away the customers of

existing businesses? !  Will existing businesses move their operations to foreign countries?

MARKET ECONOMY

DISADVANTAGES OF A COMMAND ECONOMY

Output per capita is 18 times larger in South Korea than North Korea.

Chapter 2, Lesson 2 MIXED ECONOMIES

!  A mixed economy is the most common type of economic system.

!  There are many types of mixed economies. !  Mixed economy – economic system that has some combination

of traditional, command and market economies. !  Mixed economies exist because economic systems tend to

change over time in response to crisis or because some things don’t work the way they are currently done. !  Example: Stalin rose to power in Russia in 1929 and changed the

country from a peasant society into an industrial and military powerhouse as a command economy. Many countries tried to follow this model.

!  Example: Russia’s socialist economy then collapsed in 1991 and the economy reverted to a mixed economy.

!  Example: Prior to the Great Depression in the 1930s, the U.S. was a powerful industrial country founded on free market principles. In response to needs by many during this decade, the government instituted many non-free market programs such as unemployment insurance, minimum wage, social security and price supports for agriculture.

MIXED ECONOMY

MIXED ECONOMY

!  Mixed economy – economic system that has some combination of traditional, command and market economies. !  Characteristics vary with the varying degrees of market, traditional and

command economies. !  More market economy – private ownership of productive resources !  More socialist command economy – government makes more of the decision

about the three questions !  More command economy – government ownership of most of the productive

resources !  The more socialist an economy is, the more likely the political system

is to be communist. !  For example, Cuba, China and Vietnam are more economically socialist and

politically communist, with no democracy at all. !  The more “market” and capitalist an economy is, the more

likely it is more economically developed. !  Most economies are some form of a mixed economy.

!  Communist economic philosophy originates with economic philosopher, Karl Marx (1818-1883).

!  Communism (according to Marx) – a state of economic and polit ical affairs where everyone would contribute according to his or her abil it ies and consume according to his or her needs. !  No government is ultimately needed in this utopian society. !  During the transition to communism, a strong government is needed to

serve the needs of the people. (???) !  Because communist nations have such powerful governments, they are

command economies. !  Communism would start with the struggle between workers and

property owners, where workers would rise up and overthrow the property owners.

!  No true example of Marx’s communism exists in the world today.

COMMUNIST ECONOMIES

!  Under socialism, the government controls some but not necessarily all of the resources.

!  Under socialism, the government provides some of the basic needs of the people. !  Education, jobs, transportation and health care.

!  China is a mixed economy – !  Traditional economies exist in the rural areas while government makes

the economic decisions and owns the factors of production (command) !  Cuba, North Korea and the former Soviet Union – have socialist

governments that control virtually all of the resources. !  Venezuela transitioned to a socialist country in 1999 when the

government nationalized the corporations and redistributed property.

MIXED SOCIALISM

! Norway – government owns the petroleum industry, but individuals own and control most other resources. The government does provide social welfare programs.

!  Sweden – strong private (market) economy but MANY social welfare programs. This led to very high taxes.

! Denmark, Germany, France – have significant social welfare programs.

!  South Korea, India and Thailand – have not only characteristics of market and command economies, but traditional economies as well.

! United States – !  Traditional – because some follow in their parents businesses ! Market – Individuals own most resources and make decisions about

their use. ! Command – Social programs are provided by the government

MIXED MARKET ECONOMIES

Advantages ! Command economies

can advance in their development by adding some capitalism to their economies. (China in 1980s, former Soviet Union)

!  Individuals can still own the resources while the government provides some social programs.

Disadvantages

! Countries with many social programs like health care and free education need a way to pay for them – higher taxes

MIXED ECONOMIES

Chapter 2, Lesson 3

THE GLOBAL TRANSITION TO

CAPITALISM

!  In the last 40 years, many countries have transitioned from socialist or communist economies to capitalist economies.

!  GDP per capita – GDP per person is higher in capitalist economies than command and traditional economies.

!  Capitalism provides economic growth for a country and increases their wealth and standard of l iving.

!  Stil l, a transition to capitalism can be very diff icult. !  Privatization – conversion of state owned property to private

ownership. !  Private property is important because people wil l take better

care of it if they own it. !  Vouchers – certif icates that could be used to purchase

government-owned property. !  State-owned businesses are converted to corporations that can be

bought with vouchers.

TRANSITION TO CAPITALISM

!  In command economies, political leaders have a great deal of power. Political leaders fear losing power as the country transitions to capitalism. !  In some communist countries, leaders were ousted before industry

was privatized. !  Vouchers help distribute wealth to leaders during transition. !  In some countries, leaders grabbed vouchers to retain ownership of

privatized corporations (Russia). This means the old ruling group became the new ruling group.

! When transitioning to capitalism, one must learn how to make decisions and take initiative on their own.

! Workers used to make the same salary whether they worked hard or not – now they get fired if they do a poor job.

! Costs of transitioning to capitalism – instability, unemployment and social unrest.

TRANSITION TO CAPITALISM