Ch. 2.1 Answering the Three
Economic Questions
All societies must answer three key economic
questions about the production and
consumption of goods and services. Four
different economic systems have developed
in response to these three questions.
Economic Systems
• The method used by a society to produce
and distribute goods and services
• Scarcity forces societies and nations to
answer some hard economic questions;
different economic systems have evolved
in response to the problem of scarcity
• Which economic system a society
employs depends on that society’s goals
and values.
Three Key Economic Questions
• Each society must ask itself:
• What goods and services should be
produced?
• How should these goods and services be
produced?
• Who consumes these goods and
services?
What goods and services should
be produced?
• Each society must decide what to produce
in order to satisfy its needs and wants. It is
often to distinguish between needs and
wants.
• The guns-or-butter trade off from Chapter
1 is a good example of this; because of
our limited resources, each production
decision that a society makes comes at an
opportunity cost
How should goods and services be
produced?
• Example questions: Should we produce
electricity with oil, solar power, or nuclear
power?
• Should teachers have classes of 20 students or
50 students?
• Should we produce food on large corporate
farms or on small family farms?
• To get the same outcome, the three factors of
production can be combined in different ways
(see page 24, figure 2.1 for hand tools vs.
modern mechanical equipment example)
Who consumes goods and
services?
• American business and farms produce a lot of
goods and services, but they are not unlimited;
how do we decide who to distribute our goods
to?
• This is decided by how societies choose to
distribute income; factor payments are the
income people receive for supplying factors of
production (workers receive wages, landowners
receive rent, etc.)
• Each society answers this question based on its
social values and goals
Economic Goals
• Economic Efficiency: Most societies try to
maximize what they can get for the
resources they have
• Economic Freedom: Americans have the
opportunity to make our own choices
economically; however, many people all
over the world face limitations on
economic freedom (patriotism: the love
for one’s country)
Economic Goals Continued
• Economic Security and Predictability: The
assurance that goods and services will be
available, payments will be made on time, and a
safety net (set of govt. programs that protect
people experiencing unfavorable economic
conditions) will protect individuals in times of
economic disaster
• Economic Equity: The fair distribution of wealth;
many people believe in equal pay for equal
work, but our society does not value all jobs
equally (lawyers v. nurses, computer
programmer v. truck driver, TEACHERS ;)
Economic Goals Continued
• Economic Growth and Innovation:
Innovation leads to economic growth, and
economic growth leads to a higher
standard of living (level of economic
prosperity)
• Additional Goals: Environmental
protection, universal health care, and full
employment are all other goals a society
may have
Types of Economies
• Traditional Economy: relies on habit, custom, or ritual
to decide what to produce.
• There is little room for innovation or change.
• Revolves around the family; boys take up occupations of
their fathers while girls follow in their mother’s footsteps
• Usually small communities that work to support the
entire group
• Agricultural and hunting practices usually lie at the heart
of the people’s lives, laws, and religious beliefs
• These communities usually lack modern conveniences
and have a low standard of living
Market Economy
• Economic decisions are made by the
individual and are based on exchange, or
trade
• Choices made by individuals determine
what gets made and how, as well as who
consumes the goods and services
produced
• Also called free markets or capitalism
Centrally Planned/Command
Economies
• Centrally Planned Economy:
--The central government alone decides how to
answer all three key economic questions
--Also called command economies because a
central authority is in command of the economy
Mixed Economies:
--Market based economic systems in which govt.
plays a limited role