Economic Systems and
Incentives
Should I require that you take
notes?
Review
• We have to choose , WHAT to
produce, HOW to produce, &
FOR WHOM to produce
– WHAT – Silly Bands
– HOW – Garcia buys them
– FOR WHOM – Favorite students,
or winner of Rock paper scissors
• The point, was to practice
allocating (distribute according
to a standard) goods
• There are a few ways of doing
this
•Traditional
•Command
•Market
•Mixed
Traditional economy
• Goods are made and created by
families, so families decide what
to make, how, and for who
– WHAT - Food, clothing, water,
shelter
– HOW – Family laborers, young
& old
– FOR WHOM – Family, young &
old
• Some trade is done locally, but
the economy is subsistence
based
– Basic minimum needs drive
decisions
• Ex: Inuit, Aborigines
Traditional economy
Advantages
• No questions about
WHAT, HOW, or FOR
WHOM
Disadvantages
• Economy is stagnate
– Because you do what your
parents do, your economy
does not advance
Command Economy
• A central authority
answers the WHAT,
HOW, and FOR WHOM
– WHAT – decided by
government
– HOW – decided by
government
– FOR WHOM – decided
by government
• Limits individual
freedom
– Government exists for the
people
• Ex: North Korea, USSR
Command Economy
Advantages
• Economy can change
drastically
• Services like health,
electricity, etc. provided at
little to no cost
Disadvantages
• Consumers’ wants/needs can be
ignored
• Working hard does not pay
extra
• Large bulky government needed
to drive economy
– Cannot easily adapt to minor
problems and innovation
Market Economy
• Market – not a physical place, but an
arrangement which allows buyers and
sellers to negotiate
– WHAT – what consumers want
and businesses make
– HOW – what consumers want and
businesses make
– FOR WHOM - consumers
• Ideally it is complete freedom where
anything goes
• Goods are privately owned
– Property rights – ownership of
goods is a key idea in a market
economy
• Also called capitalism
• Ex: Singapore, United States (mostly)
Basics of Capitalism
• Free enterprise
– People are allowed to choose what
they want
• Voluntary Exchange
– Trade is important but not
required
• Private Property
– Protects people’s innovations
• Profit Incentive
– The reasons people go into
business is for profits
• Competition
– Consumers make the choices
• Consumer sovereignty
– The customer is always right
Market Economy
•
•
•
•
Advantages
Individual freedom
Adjustment to new
problems/tech. is easy
Variety of goods
Consumer satisfaction is
high
Disadvantages
• Only uses productive
resources
– The young, old and sick left out
• There are not enough public
goods like education, health,
etc.
• Uncertainty for workers
Mixed Economy
• Just like it sounds
• The economy is a mix of market and
command.
– Socialism
– American capitalism
– Ex: China, Germany, United Kingdom
Government and the Economy
• Capitalism
• Socialism
• Communism
Incentives Matter
• In communist Russia,
workers had to fill
quotas of products
which were to be
divided among the
public
– Good: The public was
provided with goods
for a small or
nonexistent fee
– Bad: The incentive
was not there to make
extra in the case of
more need; no
surplus
• Also, bread was highly
valued if sold illegally
Incentives Matter:
Rhino Poaching
• Rhinos horns have long been
valued for healing powers
and for beauty
• Rhinos are valued because of
their beauty
• So the governments of
nations with the black rhino
decided to make the trade of
rhino horns and the hunting
of rhinos illegal
• What happened to the horn
trade?
– What happened to the price of
rhino horn?
Incentives Matter:
Rhino Poaching
• The price has gone up
because it is now more
dangerous
– Poaching rate has also
gone up
• What can be done
about this?
– Some government have
allowed private owners
to own and control the
black rhinos
Incentives Matter
Govt. makes horns illegal
• Price goes up
• More rhinos killed
• Government spends more
money on protecting
rhinos
• INCENTIVE: PROTECT
RHINOS
Govt. make horns legal but private
• Price goes up even more
• Rhinos still killed, but
fewer
• Businesses protect the
rhinos
• INCENTIVE: PROFIT
FROM RHINOS
Incentives Matter:
Chile’s bus system
• Under the privately owned,
market system, there were over
3000 bus companies
– Routes were confusing
• Consumer’s incentive is to find a
good company which drives fast
– Drivers paid by how many people
there were
• What is their incentive?
• Crowded buses
• Government’s response:
centralize the bus system as a
public service, like CUMTD
Incentives matter
• In order to prevent
bus crashes and
overcrowding of
buses, Chile pays
drivers based on
punctuality
– What is the
incentive for the
drivers’ now?
– What is the
incentive for
consumers now?