Chapter 26
Comparing
economic
systems
Why nations trade
•
•
•
•
Obtain sparse goods
To find new markets
To get products that other countries can make cheaper than we can
To create jobs in your own country
Comparative Advantage
• The ability of a country to produce a good at a lower cost than
other countries
• Usually due to specialization
• May also be due to fact that resources can only be found in
certain places
Barriers to Trade
Tariffs-tax on goods coming into a country that is designed to force people to
buy domestic goods
• Makes foreign goods more expensive
• Keeps American money in this country
• Protects American jobs
Barriers to Trade
Quotas-limits on the number of goods allowed in the country
• Limits the quantity available for purchase
• This leads to increase sales of American goods
• Must be careful, other countries can do the same to us
Trade Agreements
NAFTA (North American Free Trade Agreement)
• Creates free trade zone between the USA, Canada, and Mexico
• Opponents feel that it allows to many jobs to leave USA to go to Mexico for cheap
labor
• Supporters say that it increased sales for American companies and put more low
cost products on the shelves of American stores
Trade Agreements
• European Union: an organization of independent European nations with
no trade barriers so goods, services, and labor move freely (2002)
• Created one currency to make trading easier
• Created a large market to compete with competition from across the
world
Trade Agreements
WTO (World trade Organization)
• Oversees trade among most nations of the world
• Negotiates trade rules for all countries and helps to settle disputes
• Some critics feel that it favors the major corporations and neglects
workers problems
What is an economic
system?
• The organization and methods used to determine
what goods and services are produced, how they
are produced, and for whom they are produced
What are the basic types of
economic systems?
• Traditional
• Command
• Market
What is a
traditional economy?
• A system that answers the What,
How, and For Whom questions the
way they always have been answered
What is the benefit of a
traditional economy?
• There is little friction among members
because relatively little is disputed
What are the disadvantages of a
traditional economy?
• Restricts individual initiative
• Lack of advanced goods, new technology, and
growth
What is a
command economy?
• A system that answers the What, How,
and For Whom questions by central
authority
What is the structure of a
command economy?
• It has a pyramid structure
The Command Economy Pyramid
Supreme
planning
agency
Specialized planning agencies
Producing units
Consuming units
What are the strengths of a
command economy?
• Economic change can occur very quickly
• Social welfare can be enhanced
What are the weaknesses of a
command economy?
• Decision makers have the power to be
absolutely wrong
• Quality and variety of goods suffer
Price per side mirror (rubles)
Central Planners Fixing Prices
$80
S
Shortage of 400
thousand side mirrors
$60
$40
$20
Price set by planners
E
D
200 400 600 800 1000
Quantity of side mirrors (thousands per day)
Shortage of
mirrors
Planners set the
price of mirrors
below equilibrium
What is a
market economy?
• An economic system that answers the What, How, and
For Whom questions using prices determined by the
interaction of the forces of supply and demand
Who was Adam Smith?
• The father of modern economics who
believed that a free market economy acted
like an “invisible hand”
What is the invisible hand?
• A phrase that expresses the belief that the best
interests of a society are served when
individual consumers and producers compete
to achieve their own private interests
What is the advantage of a
market economy?
• It provides a wide variety of goods and
services that buyers and sellers exchange
at the lowest prices
What are criticisms of a market
economy?
Lack of competition
Externalities
Lack of public goods
Income inequality
What is a
mixed economy?
• An economic system that answers the What, How, and
For Whom questions through a mixture of traditional,
command, and market systems
What is capitalism?
• An economic system characterized by private
ownership of resources and markets
What is
consumer sovereignty?
• The freedom of consumers to cast their dollar votes to
buy, or not to buy, at prices determined in competitive
markets
What is communism?
• A stateless, classless economic system in which
all the factors of production are owned by the
workers and people share in production
according to their needs
Who was Karl Marx?
• His criticism of capitalism advanced communism
What is socialism?
• An economic system characterized by government
ownership of resources and centralized decision
making
What are the
characteristics of
socialism?
• Public ownership
• Centralization
What are the strengths of
socialism?
• An equitable distribution of income
• Rapid growth is possible
• No unemployment
What are the
weaknesses of socialism?
• Inefficiencies occur
• Absence of entrepreneurship stifles growth
A Classification of Economic Systems
Cuba China, former
Soviet Union
Pure
socialism
U.S., Canada,
Western Europe
Pure
capitalism
France, Mexico,
Latin
Sweden,
Israel America,
Japan
Hong Kong
Key Concepts
Key Concepts
•
•
•
•
•
•
What is an economic system?
What are the basic types of economic systems?
What is a traditional economy?
What is a command economy?
What is a market economy?
Who was Adam Smith?
Key Concepts cont.
•
•
•
•
•
•
What is the invisible hand?
What is a mixed economy?
What is capitalism?
What is communism?
Who was Karl Marx?
What is socialism?
Summary
41
An economic system is the set of established
procedures by which a society answers the What,
How and For Whom to produce question.
42
Three basic types of economic systems are the
traditional, command, and market systems.
43
The traditional system is based on decisions made
according to custom, and the command system answers
the three economic questions through some powerful
central authority.
44
In contrast, the market system uses the impersonal
mechanism of the interaction of buyers and sellers through
markets to answer the What, How, and For Whom
questions.
45
The Command Economy Pyramid
Supreme
planning
agency
Specialized planning agencies
Producing units
Consuming units
Capitalism is an economic system in which the
factors of production are privately owned and
economic choices are made by consumers and firms
in markets. As prescribed by Adam Smith, there is
an extremely limited role for government, and selfinterest is the driving force, held in check, or
regulated, by competition.
47
Consumer sovereignty is the determination by
consumers of the types and quantities of products
that are produced in an economy.
48
Socialism is an economic system in which the
government owns the factors of production. The central
authorities make the myriad of society’s economic
decisions according to a national plan. The collective
good, or public interest, is the intended guiding force
behind the central planners’ decisions.
49
Communism is an economic system envisioned by Karl
Marx to be an ideal society in which the workers own all
the factors of production. Marx believed that workers
who worked hard would be public spirited and would
voluntarily redistribute income to those who are less
productive. Such a communist nation described by Marx
does not exist.
50
Economic Systems Quiz
©2002 South-Western College Publishing
1. The economic system in which all of the basic
decisions are made through a centralized authority,
such as a government agency, is termed a
a. market economy.
b. capitalistic economy.
c. command economy.
d. traditional economy.
C. To answer the three basic economic questions,
the market economy uses the price system and a
traditional economy is based on customs.
2. Command economies typically suffer from
a. unemployment, but not underemployment.
b. neither unemployment nor underemployment.
c. both unemployment and underemployment.
d. underemployment, but not unemployment.
D. Command economies assign people jobs
rather than allow the market system to
determine wages and employment.
3. Adam Smith stated that the only role of government in society should be
to
a. provide defense.
b. enforce contracts.
c. do absolutely nothing.
d. both (a) and (b).
D. Adam Smith believed in a limited role of
the government to provide national defense,
education, maintain infrastructure, enforce
contracts, and little else.
4. When making economic decisions, Adam Smith urged society to
a. follow the principle of self-interest.
b. follow the principle of public interest.
c. transfer wealth according to need.
d. provide equal income for all citizens.
A. Adam Smith stated “By pursuing his own
interest he frequently promotes that of the
society more effectively than when he really
intends to promote it.”
5. The doctrine of laissez faire
a. advocates an economic system with extensive government intervention and little
individual decision-making.
b. was advocated by Adam Smith in his book The Wealth of Nations.
c. was advocated by Karl Marx in his book Das Kapital.
d. none of the above.
B. Laissez faire is a French expression
meaning “allow them to act” stated
differently, “The least government is the
best government.”
6. In Adam Smith’s competitive market economy, the question of what goods to
produce is determined by the
a. “invisible hand” of the price system.
b. “invisible hand” of government.
c. “visible hand” of public interest.
d. “visible hand” of laws and regulations.
A. The “invisible hand” refers to a system
where no central authority makes the key
economic decisions, but rather decisions
are make collectively by all consumers and
producers in the economy.
7. Adam Smith wrote that the
a. economic problems of the 18th-century England were caused by free markets.
b. government should control the economy with an “invisible hand.”
c. pursuit of private self-interest promotes the public interest in a market economy.
d. public or collective interest is not promoted by people pursuing their selfinterest.
C. Adam Smith recognized that everyone
making decisions based on their own self
interest would enhance the public interest.
8. Adam Smith, in his book The Wealth of Nations, advocated
a. socialism.
b. an economy guided by an “invisible hand.”
c. government control of the “invisible hand.”
d. the adoption of mercantilism.
B. Adam Smith advocated a laissez faire stance by
government. That is, the government should
provide the foundation for a free market system,
but should not be a major participant in
answering the questions of What, How, and for
Whom.
9. The economic system in which private individuals own the factors of
production is
a. a planned economy.
b. capitalism.
c. collectivism.
d. socialism.
B. For answers a,c, d, resources or factors of
production are owned by the government.
10. Which of the following is not a basic characteristic of capitalism?
a. Economic decisions occur in markets.
b. Factors of production are privately owned.
c. Income is distributed on the basis of need.
d. Businesses make their own product and price decisions.
C. Karl Marx believed people would be motivated by the
principle “from each according to his ability, to each
according to his need.”
11. According to Karl Marx, under capitalism,
a. profits would be shared fairly.
b. incomes would be distributed equally.
c. workers would be exploited and revolt against owners of capital.
d. workers would actually own the factors of production.
C. Karl Marx believed that private
ownership and profits lead to exploitation.
The result is a class struggle between a
few “haves” and “havenots.”
12. Karl Marx predicted which of the following?
a. market system would self destruct.
b. “haves” would revolt against the “have-nots.”
c. wealthy were entitled to profits as their reward for risk-taking.
d. none of the above.
A. Karl Marx argued the market system
would destroy itself because owners would
go too far and pay starvation wages in order
to maximize profits.
13. How many nations in the world today operate totally according to Karl
Marx’s theory of communism?
a. None.
b. Several.
c. Only the United States.
d. Many.
A. Under Marx’s idealized society of communism,
people would distribute wealth according to
need and no central authority would be
necessary.
14. In Marx’s ideal communist society, the state
a. actively promotes income equality.
b. follows the doctrine of laissez faire.
c. owns resources and conducts planning.
d. does not exist.
D. Under Marx’s idealized society of
communism, individuals with ability
would distribute the wealth of society
according to each person’s need.
15. Karl Marx was a (an)
a. 19th-century German philosopher.
b. 18th-century Russian economist.
c. 14th-century Polish banker.
d. 19th-century Russian journalist.
A. Karl Marx was born in Germany, the son of a lawyer.
Marx was an outstanding student at Berlin University.
In 1841, after receiving a doctorate in philosophy, he
turned to journalism.
END