Chapter 2 – Economic Systems
 Resources are scarce everywhere, thus:
 Every country must answer three economic questions
 What goods and services should be produced?
 How should these goods and services be produced?
 Who consumes these goods and services?
 Economic System – the structure of methods and
principles a society uses to produce and distribute goods and
services.
Economic Systems
Economic goals and societal values
 Every society pursue each goal to some degree:
 Economic Efficiency – maximize what can be produced
 can’t be efficient unless you can provide the right goods to the right
people at the right time
 Economic Freedom – the opportunity for individuals to
make their own choices
 Economic Security – people want to know that
goods/services are available when needed and that they will get
paid on time
 Safety net – governments programs like workman’s compensation,
unemployment compensation, social security disability payments
Economic goals and societal values
 Economic Equity – deciding who gets how much
payment. Each society is different.
 Economic Growth – economy should grow with rising
population and for individuals to have wage growth
 Standard of Living – level of economic prosperity
 Innovation – process of bringing new methods, products, or
ideas into use
 Instrumental in economic growth i.e. industrial revolution, computer
technology, etc.
 Goals in Conflict – some goals undermine others i.e.
safety nets can slow economic growth because they are
expensive
Types of Economies
 Traditional Economy
 Oldest and simplest economic system
 Relies on habit, custom, or ritual to answer three economic
questions
 Little room for innovation
 Revolves around a family unit
 Found in small, close knit communities
 Individuals work to support the community not themselves
 Ex. Native Amazon tribes, African tribes, some 3rd world
nations
Chapter 2.1 Questions
 What is an Economic System?
 What must happen for a nation’s standard of living to
improve?
 Why would it be inefficient for a manufacturer to produce
audio cassettes instead of CDs today?
 Which basic economic goals can be achieved easily in a
traditional economy? Which cannot? Explain
Free Market System
 Market – any arrangement that allows buyers and sellers to
exchange things
 These allow us to exchange things we have (money) for things
we want (goods/services)
 Specialization – concentration of the productive efforts of
individuals and businesses on a limited number of activities
 This leads to the most efficient use of capital, land & labor
Free Market System
 Free Market Economy – answers to the three economic
questions are made by voluntary exchange in markets.
 Also known as Capitalist Economy
 Individuals and privately owned business own the factors of
production, make what they want, and buy what they want
Free Market System
 Factor Market – When firms purchase factors of production from
households
 Hiring workers
 Renting land or buildings
 Product Market – households buy the goods and services that firms
produce
 How does the marketplace function?
 Self Interest – buyers and sellers consider only their own personal gain.
This motivates people to act.
 Incentives – hope of reward or fear of penalty that encourages a person to
behave in a certain way
 Competition – the struggle among producers for the dollars of consumers
 Self interest and competition work together to regulate the marketplace
Free Market System
 Advantages of the Free Market:
 Economic Efficiency – market responds efficiently to rapidly
changing conditions
 Economic Freedom – individuals work where they want,
businesses produce what they want, households consume what they
want
 Economic Growth – competition encourages innovation, thus free
markets encourage growth
 Additional Goals
 Consumer Sovereignty – the power of consumers to decide what gets
produced
 There is no country in the world that has a truly “Free Market”
Chapter 2.2 Questions
 How does specialization make us more efficient?
 How do self-interest and competition affect the free market?
 Why do you think no country has a pure free market
economy?
Centrally Planned Economies
 Centrally Planned Economy – the government, rather
than individual producers and consumers, answer the key
economic questions
 Government owns the land and capital
 Government decides where people work and what they are paid
 Also known as a “Command Economy”
 Opposed to private property, free market pricing, competition
and consumer choice
Centrally Planned Economies
 Two types of government associated with Command
Economies
 Socialism – not a single economic system; rather, a range of
economic and political systems based on a belief that wealth
should be evenly distributed throughout society
 Communism – central government owns and controls all
resources and means of production and makes all economic
decisions
 Soviet Union
 China
Centrally Planned Economies
 Disadvantages of Centrally Planned Economies
 Economic Efficiency – since government owns everything
and fixes wages, workers lack incentive to work faster or
produce more
 Economic Freedom – individual freedoms sacrificed in order
to pursue societal goals
 Economic Growth – innovation is not promoted and they do
not encourage entrepreneurship
 Economic Equity – government officials are typically wealthy
and workers are typically poor and suffer shortages
 Additional Goals – has provided secure jobs and income
Chapter 2.3 Questions
 What does a centrally planned economy oppose that a market
economy encourages?
 Explain why each of the following goals is difficult to achieve
in a centrally planned economy:
 Economic freedom
 Economic growth
 Who benefits and who suffers most from a centrally planned
economy? How?
Mixed Economies
 Most economies today are “mixed”
 Mixed Economy – a market-based economic system in
which the government is involved to some extent
 the degree to which the government is involved varies from
nation to nation
Mixed economies
Mixed Economies
 A wide variety of Mixed Economies exist
 Economic Transition – a period of change in which a
nation moves from one economic system to another
 Privatization – the process of selling businesses or services
operated by the government to individual investors
 China is currently selling state owned businesses to individuals
and then letting them compete in the market place
Mixed Economies
 U.S. Economy
 Founded on Free-Market principles
 Free Enterprise System – an economic system characterized by
private or corporate ownership of capital goods
 Government intervention plays a key role in economy
 However, government allows marketplace to operate with
minimal regulation
 U.S. enjoys a high level of economic freedom
Chapter 2.4 Questions
 Why have some nations began an economic transition to a
free enterprise system?
 How does laissez faire differ from a centrally planned
government?
 How is China carrying out privatization?