Answering the Three Economic Questions
Chapter 2 Section 1
Economics
• Resources are more scarce in some nations
• Economic System: the method used by a society to
produce and distribute goods and services
Three Key Economic Questions
• What goods and services should be produced?
• How should these goods and services be produced?
• Who consumes these goods and services?
Different Economies
• Market Economy- economic decisions are made by
individuals and are based on exchange or trade
• Centrally Planned Economy- the central government alone
decides how to answer all three economic questions
• Mixed Economy- Market based economic systems in
which government plays a limited role
The Free Market
Chapter 2 Section 2
The Free Market
• Market: an arrangement that allows buyers and sellers to exchange
things
• They exist because no one is self –sufficient
• Specialization
Free Market Economy
• Economic systems that are based on voluntary
exchanges in markets
• Individuals and businesses answer the three
economic questions
• Functions best in a democracy
• Circular flow model (p.30)
Adam Smith
• Wealth of Nation
• Influenced western economies
Competition
• Incentive: the hope of reward that encourages a person to behave a certain
way
• Competition: struggle among producers for the dollars of consumers
• The Invisible Hand: term economists use to describe the self-regulating nature
of the market place
Centrally Planned Economy
Chapter 2 Section 3
Centrally Planned Economies
• Opposite of a Free Market Economy
• Oppose private property, free market pricing, competition,
and consumer choice
• The Central Government answer the three economic
questions, rather than the individual
– What to produce
– How much
– How much to charge
Socialism
• A social / political philosophy based on the belief that
democratic means should be used to distribute wealth
• Only possible if the public controls the economic power
• Government often owns factories and large industries
Communism
• Arose from the philosophy of socialism
• Centrally planned economy
• All power lies with the central government
• Believe a socialist society can only come after a violent revolution
• Authoritarian
Communism
The Former Soviet Union
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Began 1917
Central planning was introduced in the 1920s
Most concerned with power- most resources went to military
Broke Up in 1991
Soviet Agriculture
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Large state owned farms
Farmers worked for daily wages set by the farmer
Collectives- large farms leased from the state to peasant farmers
Required to produce what the government tells them to
Soviet Industry
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Factories-state owned
Most resources used for the military
Little resources left for other needs
Lack of incentives
Soviet Consumers
• Who cares?
– Guaranteed a job
• “We pretend to work, they pretend to pay us”
• Long Lines
• Very little luxury
Problems with this Economy
• Poor Quality
• Serious Shortages
• Diminishing Production
Modern Economies
Chapter 2 Section 4
The Rise of Mixed economies
• There are no longer any economies that are completely free market
or centrally planned
Limits of Laissez-Faire
• Both centrally planned and free market economies have
drawbacks
• Adam Smith: Laissez faire (the idea that the government
should not intervene in the market place)
• Since Smith, government has become more involved in the
economy
Limits of Laissez-Faire
• How well could the market place provide for national defense or
roads?
• Government create laws protecting property rights and enforcing
contracts
Comparing Mixed Economies
• Compare the charts on P. 30 & 42
• The foundation of the US economy is the free market
• Free Enterprise: ownership and investments are held by
individuals or corporations
• Continuum of Mixed Economies
– (p. 43…Where do we fall?)
Ends of the Spectrum
• North Korea’s government owns all property, and 95% of
economic output
• Hong Kong’s government protects private property, and
rarely interferes in the free market
The U.S. Economy
• Free enterprise economy…but the government intervenes
to keep order, provide services, and promote general
welfare
• US laws protect private property