What is an
Economic System?
An organization and methods used to
determine:
WHAT goods and services are
produced and in WHAT quantity.
 HOW they are produced.
 WHOm are the goods and services
produced for?
1
What are the basic types
of Economic Systems?
• Traditional
• Command
• Market
2
CUSTOM
TRADITION
What is a
Traditional Economy?
A system that answers
the What, How, and For
Whom questions the
way they always have
been answered
3
What is the Benefit of
a Traditional
Economy?
There is little friction among
members because relatively
little is disputed
4
What are the
Disadvantages of a
Traditional Economy?
Restricts individual initiative
Lack of advanced goods, new
technology, and growth.
5
What is a
Command Economy?
A system that answers the What,
How, and For Whom questions
by central authority
6
What are the Strengths
of a Command
Economy?
stable = lots of security.
Social welfare
Equity
7
What are the
Weaknesses of a
Command Economy?
Lack of growth and expansion.
Decision makers have the power to be
absolutely wrong.
Quality and variety of goods suffer.
Lack of motivation = lack of innovation
Self-interest
Private property
Stagnate economy
8
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
producers
consumers
9
What are the advantages
of a Market Economy?
Variety
Innovation
Higher quality
Lower prices
Self regulating
10
What are Criticisms of a
Market Economy?
• Dynamic and unpredictable
• Lack of stability and security.
• Externalities-How do you deal with
things outside of supply and demand?
• Lack of public goods
• Income inequality-large gap
between the rich and the poor.
11
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
12
What is Capitalism?
An economic system
characterized by
private ownership of
resources and markets
13
Who was Adam Smith?
• He wrote the “Wealth of Nations” 1776
• Advocate of Free Enterprise/capitalism
• Famous for acknowledging the “invisible
hand”
• Central difference-Capitalism vs
Socialism/Communism
– Individual vs Community
14
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
15
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
16
Who was Karl Marx?
He co-authored the
“Communist Manifesto”
1848
His criticism of capitalism
advanced communism
17
What is Socialism?
An economic system
characterized by
government ownership of
resources and centralized
decision making
18
What are the
Characteristics of
Socialism?
Public ownership
Centralization
19
What are the Strengths
of Socialism?
• A more equitable
distribution of income
and benefits
• reduced unemployment
20
What are the
Weaknesses of Socialism?
Inefficiencies occur
Absence of entrepreneurship
stifles growth and
innovation
21
A Classification of Economic Systems
Cuba China, former
Soviet Union
U.S., Canada,
Western Europe
Pure
capitalism
Pure
socialism
France, Mexico,
Sweden, Latin
Israel America,
Japan
Hong Kong
22
Key Concepts
23
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?
• Who was Karl Marx?
24
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?
25
Summary
26
An economic system is the set
of established procedures by which
a society answers the What, How
and For Whom to produce question.
27
Three basic types of economic
systems are the traditional, command,
and market systems. 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. 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.
28
The Command Economy Pyramid
Supreme
planning
agency
Specialized planning agencies
Producing units
Consuming units
29
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 self-interest is the
driving force, held in check, or
regulated, by competition.
30
Consumer sovereignty is the
determination by consumers of the
types and quantities of products that
are produced in an economy.
31
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.
32
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.
33
Chapter 29 Quiz
©2000 South-Western College Publishing
34
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.
35
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.
36
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.
37
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.”
38
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.”
39
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.
40
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 self-interest.
C. Adam Smith recognized that everyone
making decisions based on their own self
interest would enhance the public interest.
41
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. 42
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.
43
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.”
44
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.”
45
12. Karl Marx predicted which of the
following?
a. market system would self destruct.
b. “haves” would revolt against the “havenots.”
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.
46
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.
47
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.
48
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.
49
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