Helen Naughton
Department of Economics
University of Montana

 Economy—in Greek “Household management”
 Microeconomics—study of household and firm decisions
 Macroeconomics—study of country-level indicators
(government interest rates, unemployment)

1. What goods and services are produced?
2. Which resources are used in production?
3. Who gets to consume the goods and services?

 The system for answering The Economic Questions:
 Does the government choose what and how much is produced or is it market-driven?
 Who decides which resources are used?
 Who decides how goods are distributed?

 Economic decisions based on customs and beliefs handed down through generations

 The economic system where government answers most of The Economic Questions for its people.
 Former Soviet Union
 North Korea

Business in a Command System
 The government answers The Economic Questions:
 The government determines what inputs to use
 The government determines the quality of inputs
 The government sets employees wages
 The government sets business hours

 The economic system where markets are allowed to operate freely:
 Goods and services are produced if people are willing to pay for them in the market.
 Input markets drive which resources are used in production.
 Those who are willing to pay for the goods and services receive them.

 I answer The Economic Questions:
 I determine what inputs to use
 I determine the quality of my inputs
 I set my employees wages
 I set my business hours

 A little bit of each—MIXED SYSTEM!
 Some markets are allowed to operate freely.
 Some production and allocation decisions are made by the government.
 Some economic decisions are made based on tradition.

 I and the government answer
The Economic Questions:
 I determine what inputs to use
 The government determines the quality of my inputs
 Minimum standards for food safety and other health hazards (no lead in paint or gasoline).
 I set my employees wages
 The government sets the minimum wage
 I set my business hours
 The government decides if I am safe to operate

Traditional System
Natives/A borigines
North
Korea
Command System
US
Market System

 It is reasonable to state that US is more marketbased system than most countries overall.
 Yet, we could likely find specific markets where the
US government interferes more than other governments.
 For example, the US government has a tradition of offering support to US steel workers to protect the industry jobs and income.

Why has the US (mostly) embraced the market economy?
 To promote efficiency
 To make the economic benefit/pie as big as possible
 To minimize waste

 Markets do not ensure that goods and services are allocated fairly (or that everyone gets enough to eat).
 Costs and benefits of the goods and services may be external to the market.
 A person who does not pay for fireworks can easily enjoy the fireworks. (External benefits)
 A person who does not use a car can get sick from pollution emitted by cars. (External costs)

1. Increase equity
 Tax income and wealth
 Provide goods and services to the poor

2. Provide goods with external benefits
(private markets underprovide these goods)
 National security
 Infrastructure (roads and bridges)
 Educated and healthy citizenry

3. Regulate goods with external costs
(private markets overproduce these goods)
 Ensure copper mining pays for all costs (including the cost of polluted water in the river)
 Control hazardous waste disposal
 Charge gasoline taxes to help pay for the external cost of air pollution from cars

Balancing Roles of the Market and the Government
 Hotly debated in the US political system
 Problems with finding the balance:
 External costs and benefits are difficult to measure.
 While redistributing income may reduce inequality, it also lowers incentives for work (some argue especially for the highly productive).

Traditional System
Command System Market System