Economic Systems
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Chapter 2: Economic Systems
KEY CONCEPT
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An economic system is the way in which a society uses its resources
to satisfy its people’s unlimited wants.
WHY THE CONCEPT MATTERS
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An economic system determines what to produce, how to produce,
and for whom to produce. Countries have mixed systems, but some
systems give more economic and political freedom and create more
wealth than others.
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Introduction to Economic Systems
Types of Economic Systems
KEY CONCEPTS
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Economic system—how society uses resources to satisfy people’s
wants
Three basic systems: traditional, command, and market economies
Mixed economies have features of more than one type of system
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Types of Economic Systems
TYPE 1: Traditional Economy
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Traditional economy centers on families, clans, or tribes
– decisions are based on customs and beliefs
Everyone has a set role; no chance of deviating from pattern
Good of the group always comes before individual desires
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Types of Economic Systems
TYPE 2: Command Economy
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Command economy—government makes economic decisions
– determines what to produce; how to produce; who gets products
Wants of individual consumers rarely considered
Government owns means of production: resources and factories
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Types of Economic Systems
TYPE 3: Market Economy
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Market economy driven by choices of consumers and producers
– consumers spend money, go into business, sell their labor as they
wish
– producers decide how to use their resources to make the most
money
Consumers, producers benefit each other when they act in selfinterest
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Characteristics of Traditional Economies
KEY CONCEPTS
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Early societies all had traditional economies
Traditional systems help societies survive
Tend to be inefficient; do not adapt to change
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Characteristics of Traditional Economies
TRAIT 1: Advantages and Disadvantages
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Advantages: little disagreement over goals, roles
– methods of production, distribution determined by custom
Disadvantages: as result of resistance to change, less productive
– do not use new methods; people not in jobs they are best suited
for
– low productivity results in low standard of living
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Characteristics of Traditional Economies
TRAIT 2: Under Pressure to Change
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Many traditional economies under pressure to change
Kavango people of Namibia lived as subsistence farmers for
centuries
Modern telecommunications brought Kavango images of outside
world
– thousands have moved to cities
– a few have turned to commercial farming
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Reviewing Key Concepts
Use each of the terms in a sentence:
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traditional economy
command economy
market economy
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Command Economies
Government Controls
KEY CONCEPTS
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Centrally planned economy—central government makes all decisions
Decides for whom to produce in part by setting wages
– only some people have money to buy available products
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Government Controls
EXAMPLE: Government Planning
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In all societies, government exerts some control over people’s lives
In centrally planned economy, government exerts great control
– determines businesses to operate, amount produced each month
– determines who is employed, work hours, pay scales
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Government Controls
EXAMPLE: Socialism and Communism
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Karl Marx influenced some societies to adopt command economies
– socialism—government owns some of the factors of production
– communism—no private property; little political freedom
Authoritarian system requires total obedience to government
– communism is authoritarian socialism
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Government Controls
EXAMPLE: Socialism and Communism
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Democratic socialism established under democratic political process
– government owns basic industries
– other industries private
– central planners make decisions for government-owned industries
– central planners might control other sectors, such as health care
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Karl Marx: Economic Revolutionary
A New View of Economics
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Marx lived during Industrial Revolution
Argued factory owners used workers as resource
– exploited workers by keeping wages low to increase profits
– workers would rebel, establish classless society
Wrote The Communist Manifesto (with Friedrich Engels), Das Kapital
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Command Economies Today
KEY CONCEPTS
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No pure command economies today
– modern telecommunications bringing about change
Some economies still have mostly command elements
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Command Economies Today
North Korea
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Communist North Korea used resources for military, not necessities
– built large army; nuclear weapons program
– In 1990s and early 2000s, millions died of hunger, malnutrition
– In 1990s, production decreased and economy shrank
– Since 2003, some market activity allowed
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Command Economies Today
Impact of Command Economies
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In theory, command systems fair to everyone; In practice, many
disadvantages
– central planners do not understand local conditions
– workers have little motivation to be productive or conserve
resources
– artificially low prices lead to shortages
– people sacrificed to carry out centrally planned policies
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Reviewing Key Concepts
Write a brief paragraph explaining the links between the
following three terms:
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centrally planned economy
socialism
communism
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Market Economies
Fundamentals of a Market Economy
KEY CONCEPTS
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Private property rights—right to own businesses and resources
Property means material objects, money, intellectual property, labor
Market—place or situation where people buy and sell goods,
services
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Fundamentals of a Market Economy
FEATURE 1: Private Property and Markets
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Private property rights must be defined and protected by law
Buyers must be sure sellers have right to sell products they offer
Sellers must be sure they will be paid for their products
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Fundamentals of a Market Economy
FEATURE 2: Limited Government Involvement
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Laissez faire—government should not interfere in economy
Capitalism—system having private ownership of factors of production
– says producers will create products consumers demand
Actual market economies all have some government involvement
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Fundamentals of a Market Economy
FEATURE 3: Voluntary Exchange in Markets
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Voluntary exchange—traders believe they get more than they give
up
In market economy, most trade is exchange of product for money
Profit—financial gain from business transaction
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Fundamentals of a Market Economy
FEATURE 4: Competition and Consumer Sovereignty
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Competition—sellers’ efforts to get business by offering best deal
Consumer sovereignty—buyers choose products, control what is
produced
Competition controls self-interested behavior
– sellers offer low price or high value to please consumers, make
profit
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Fundamentals of a Market Economy
FEATURE 5: Specialization and Markets
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Specialization—people concentrate their efforts in the activities they
do best
– encourages efficient use of resources
– leads to higher-quality, lower-priced products
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Circular Flow in Market Economies
KEY CONCEPTS
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Circular flow model illustrates how interactions occur in a market
Represents the two key decision makers: households, businesses
Shows the two markets where households and businesses meet
– goods and services
– resources
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Circular Flow in Market Economies
Product Markets
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Product market—market where goods and services bought and sold
– includes all purchases by individuals from businesses
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Circular Flow in Market Economies
Factor Markets
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Factor market—market for the factors of production
– land, labor, capital, entrepreneurship
Individuals own all factors of production
– own some outright, such as labor; some indirectly, such as stocks
– individuals are producers; businesses are customers
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Circular Flow in Market Economies
Circular Flow
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Circular flow model shows how market economies operate
– outside arrow shows flow of money
– inside arrow shows flow of resources and products
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Impact of Market Economies
KEY CONCEPTS
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Late 1940s to early 1990s, many countries had command systems
– U.S.S.R., Eastern Europe, China, much of SE Asia, Cuba, North
Korea
Most of these countries have now adopted market systems
– remaining communist countries using some market measures
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Impact of Market Economies
Advantages
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Individuals free to make economic choices, pursue own work
interests
Less government control means political freedom, less bureaucracy
Locally made decisions mean better use of resources, productivity
Profit motive ensures resources used efficiently, rewards hard work
– resulting competition leads to higher-quality, more diverse
products
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Impact of Market Economies
Disadvantages
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Pure market economy has no way to provide public goods and
services
Does not give security to sick or aged
During U.S. industrial boom, business owners rich, workers low pay
Businesses did not address problems caused by industrialization
Industrialized societies adopt some government control of economy
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Reviewing Key Concepts
Explain the relationship between the terms in each of
these pairs:
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private property rights and market
laissez faire and capitalism
specialization and profit
factor market and product market
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Modern Economies in a Global Age
Today’s Mixed Economies
KEY CONCEPTS
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Mixed economy has elements of traditional, command, market
systems
– most common type of economic system
Traditional, command, market economies adopt elements from others
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Today’s Mixed Economies
Life in a Mixed Economy
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Family farming in U.S. serves as example of mixed economy
– traditional: all members of family help bring in harvest
– command: affected by government—public school, roads, Social
Security
– market: own land, sell their products in competitive market
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Today’s Mixed Economies
Types of Mixed Economies
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Most economies emphasize one type; U.S. basically has market
system
Many European countries greater mix of market and command
elements
– France—government controls some industries; provides social
services
– Sweden—state owns part of all companies; lifelong benefits, high
taxes
– Namibia—traditional; state supports market, foreign investment
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Trends in Modern Economies
KEY CONCEPTS
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Economies change in response to natural, social, political changes
East European economies changed after fall of communism
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Trends in Modern Economies
TREND 1: Changes in Ownership
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Economies in transition often go through changes in ownership
To nationalize is to change from private to government ownership
To privatize is to change from government to private ownership
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Trends in Modern Economies
TREND 2: Increasing Global Ties
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Growth of global economy—economic actions across national
boundaries
– recent agreements open up world markets to trade among
countries
– fast, safe, cheap transport of resources, products eases
distribution
– phone, computer links make financial transactions quick,
inexpensive
– cross-border business partnerships lower research, production
costs
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Reviewing Key Concepts
Write a sentence that illustrates the meaning of each of
the following terms:
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mixed economy
Nationalize
Privatize
global economy
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Case Study: Contrasting Economies: North
Korea and South Korea
Background
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Korea was a single country until end of World War II
North Korea has communist government, command economy
South Korea is democracy with market economy
What’s the Issue?
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How effective are command and market economies?
Thinking Economically
1. Based on documents A and C, in which country does the government
appear to be more involved in controlling business and the economy?
2. Based on documents A and C, what can you infer about the effects of
government activities on productivity in the two nations?
3. In today’s global economy, is a command economy or a market
economy more likely to succeed? Support your answer with
information presented in the three documents.
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