Economic Systems

Chapter 2

Economic Systems•In this lesson, students will examine the four

economic systems.•Students will be able to define the following

terms:•An Economic System•Traditional Economy•Free Market Economy

•Centrally Planned Economy •Mixed Economy

What goods and services will a countryproduce?

An Economic System

• An economic system is a method used by a society to produce and distribute goods and services.

• There are three key questions addressed by every economic system:• What goods and services will be produced?

• How will these goods and services be produced?• Who will consume these goods and services?

• What Should be produced? We live in a world of scarcity and trade-offs. If more of one particular item is produced, then less of something else will be produced.

• How Should It Be Produced? After deciding what to produce, an economic system must then decide how those goods and services will be produced. A decision must be made as to how the combination of available inputs will get the job done for the least cost.

• For Whom Should It Be Produced? After goods or services are produced, the type of economic system under which people live determines how the goods and services will be distributed among its members. Most goods and services in the United States are distributed to individuals and businesses through a price system.

Who will consume these goods?That is a key economic question.

Nations, like people, answer the key economic questions differently.

A Traditional Economy

• In a traditional economy, people live and work as their ancestors lived and worked.

• In a traditional economy, we

• produce what our ancestors produced.• produce it the way our ancestors did.• distribute it the way our ancestors did.

It’s all about the ancestors.Traditional economies do not

encourage change.

A Free Market Economy

• In a free market economy, people are free to buy and sell whatever their money allows within the legal limits of the law.

• The government does not interfere in the business of business.

• The individual has economic freedom.

In a free market, individuals are freeto buy and sell.

A Centrally Planned Economy

• In a centrally planned economy, the government makes all economic decisions.

• The government answers the three key economic questions.

• Karl Marx advocated a centrally planned economy.

Communists advocate centrally plannedeconomies.

A Mixed Economy

• Modern nations have mixed economies.

• A mixed economy combines elements of the other three economic systems.

• However, it is important to remember that nations mix their economic systems differently.

Just as every person mixes a milkshakedifferently, so, too, do nations mix theireconomies differently.

Questions for Reflection:

• Define an economic system.• What are the three key economic questions?• Describe life in a traditional economy.• Describe life in a free market economy.• How does a centrally planned economy differ from a free

market economy?• Why do modern nations prefer mixed economies?

The Free Market•In this lesson, students will identify characteristics

of the Free Market.•Students will be able to define the following

terms:•Adam Smith•Laissez-faire•Self-interest•Competition

Adam Smith was the first economist.In his book, The Wealth Nations (1776),Adam Smith explained how free markets

functioned.

Markets are places where people can exchange the things they have for the

things they want.

The Free Market

• In a free market economy, people are free to buy and sell whatever they want within the legal limits of the law.

• Obviously, we do not live in a completely free market economy.

• There are some restrictions on what we can buy and sell.

In the United States today, there are someproducts that we cannot legally buy. We

can buy a rifle but not this gun.

Laissez-faire

• Laissez-faire is the doctrine that states that the government should not intervene in the marketplace.

• It means “let them do (as they please)”.

• In a free market, the government does not regulate the economy.

Adam Smith believed that an Invisible Handexisted or that the market would always fixitself.

The Invisible Hand is the idea that the economy fixes itself. If there is demand for a good that currently does not exist in the market, some enterprising entrepreneur

will eventually produce it.

Adam Smith

• Adam Smith was the first person to explain how the free market functioned.

• He did not invent the free market rather he explained how it functioned.

• His book, The Wealth of Nations, is still considered a classic today.

Competition and self-interest allow marketsto function effectively.

Competition and Self-Interest

• Competition is the struggle among producers for the dollars of consumers.

• Self-interest is acting on behalf of one’s personal gain.

• Competition and self-interest make markets work.

Competition leads to lower prices andbetter quality. When consumers havechoices, producers must offerworthwhile products.

Every person has his or her best interestin mind. This photograph is an example.The tutor is interested in earning moneyand the student is interested in learning.

Questions for Reflection:

• Who was Adam Smith?• How does a free market economy differ from a traditional

economy?• Define Laissez-faire.• How does the market fix itself?• How do competition and self-interest help the market function

efficiently?• What is the Invisible Hand?

A Centrally Planned Economy In this lesson, students will identify

characteristics of a centrally planned economy.

Students will be able to identify and/of define the following terms:

Centrally Planned EconomyCommunism

Problems of a Centrally Planned Economy

Karl Marx advocated a centrally plannedeconomy in his book, The Communist Manifesto (1848).

In the early days of the Industrial Revolution,workers were exploited or mistreated. Children even worked in factories.

Sure, a few industrialists and capitalistsBecame very wealthy but…

Most people worked long hours for low wages in unsafe working conditions.

Karl Marx encouraged workers to uniteand violently overthrow the Capitalistclass in order to create a more justsociety.

“Workers of the world unite;you have nothing to lose but

your chains.”

Marxism

Marxism is frequently referred to as communism.Characteristics of a Marxist Society:

• Dictatorship• Government ownership of the Factors of Production

• Economic Equality

It sounds like paradise: A society wherethere is no poverty, no want but…

Problems of a Centrally Planned Economy

Many problems exist in centrally planned economies.The Problems of a Centrally Planned Economy:

• Workers lack incentive because all workers are rewarded equally.

• Productivity and efficiency decline.• Innovation is not rewarded.

• Individual freedoms are sacrificed.

Think about it!Would you work hard if you were rewarded

The same as the lazy worker beside you?

Eventually, the Soviet Union collapsed andthe formerly Communist republics began

to transition to largely free marketeconomies.

Transition has been difficult for Russia.A new economic perspective must becreated and previously Government-owned factories must be privatized.

Questions for Reflection:

• How does a centrally planned economy differ from a free market economy?

• Who was Karl Marx and what did he advocate?• Describe a Communist society.• What problems are created by centrally planned economies?• Define transition.

Modern Economies

Students will be able to define and/or identify the following concepts and terms:

Mixed EconomyLaissez-faire

Free Enterprise

In this lesson, students will identify characteristics of modern economies.

Just as this apple is not perfect, economicsystems are not perfect. While a centrallyplanned economy has many problems, afree market economy is far from perfect.

A Mixed Economy• A mixed economy combines elements of

different economic systems to meet the needs of the society.

• While modern economies are mixed, every mixed economy is slightly different from every other mixed economy.

• Some nations lean more towards central planning with some private ownership while other nations are predominantly free market with limited government intervention.

The Chinese communists seized powerin 1949. However, today, the Chineseembrace elements of the free market.

The Chinese communists realized that workers needed incentives or reasonsfor increasing productivity.

The United States is a mostly freemarket economy. However, the government does intervene in themarket.

It is important to remember that manyabuses occurred in a totally free market.Child labor is one example of thisabuse.

Laissez-faire

• Laissez-faire was the belief that the government should not intervene in the market.

• It meant “let them do (as they please).”

• It allowed businesses to operate without any restrictions.

Without government intervention, warninglabels would not exist.

Heroin could be purchased in yourlocal supermarket.

Government intervention protectsour environment and our lives.

Free Enterprise

• The United States’ economic system is called the Free Enterprise system.

• A Free Enterprise system is a mostly free market economy with limited government intervention.

• The government does intervene in the economy when it is in the public interest.

E. Napp

So, modern nations have mixed economies.However, like milkshakes, mixed economiesare not mixed the same.

E. Napp

Questions for Reflection:

• Define a mixed economy.• What problems are created by central planned economies?• What problems are created by free market economies?• Define Laissez-faire.• What is the Free Enterprise system of the United States?