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CHAPTER 2: ECONOMIC SYSTEMS
… how each society answers the three fundamental questions of what, how,
and for whom to produce
Note that there are as many real-world economic systems as there are
nations, but we will look at the two extremes: pure capitalism and pure
command socialism.
As we go through these economies, consider:
1. Who owns the means of production?
2. Who makes the economic decisions?
Means of Production: the raw materials, factories, farms and other
economic resources used to produce g/s
The Model of Pure Capitalism
…an economic system in which the means of production are privately
owned and fundamental economic choices are made by individual buyers
and sellers interacting in markets
Basic Elements of Pure Capitalism:
1.
Private Property and Freedom of Choice
• Private individuals and groups own the means of production
• Businesses are free to produce what they wish and to purchase
resources from whomever they choose
• Individuals may also spend their resources as they choose
2.
Self-Interest
• The driving force of capitalism (via the invisible hand)
The Invisible Hand: as individuals pursue their own best interests, they
promote the good of society as a whole (Adam Smith)
i.e. business is driven by profits: make g/s consumer want most
workers driven by wages: take jobs in higher paying sectors
consumers driven by prices/quality: buy valued products
Thus, each person, acting in their own best interest would be led by this
invisible hand to produce the g/s desired by the society.
A. Barnaby @ CCC
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3.
Markets and Prices
Capitalism is the “market system”
Market: actual or potential buyers and sellers of a particular item
• Does not need to be a physical location
• May be regional, national, international
Market prices are determined by the interaction of buyers and sellers and
serve the following purposes:
• Ration societies limited g/s to those who want/need it most
• Motivate businesses to produce the most desired g/s
4.
Competition
• Pure capitalism requires pure competition to work
Pure Competition: a market where many buyers and sellers, who are small in
size, interact to determine prices
• Thus, prices are determined by the market mechanism and not a
few powerful buyers and sellers
Limited Government Intervention
• The market answers the three fundamental economic questions, not
the government
• The only role of the government is to ensure an environment where
the market economy can function
5.
Laissez-faire economy: one where the government will “let the people do as
they choose”
A. Barnaby @ CCC
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HOW CAPITALISM ANSWERS THE THREE FUNDAMENTAL
QUESTIONS
1. What to Produce
• Producers are motivated by profits
• The most profitable products are the ones the consumers desire
most
• Thus, producers are forced to be responsive to consumer’s
wants and needs
Consumer sovereignty: consumers dictate which g/s businesses will
produce
2.
How to Produce
• Capitalists choose the least-cost approach
because lower costs=higher profits
e.g. in the US and Japan, skilled labor is very expensive, so often
mechanized techniques (such as robots in the auto industry) are
used
3.
For Whom to Produce
• Output is given to those who desire and can afford the g/s price
STRENGTHS AND WEAKNESSES OF CAPITALISM
Strengths:
• economic efficiency ; businesses produce the g/s that consumers want
most and use the least amount (cost-wise) of economic resources
• economic freedom
• political freedom ; economic and political power is separate
Weaknesses:
• unequal distribution of wealth that is perpetuated
• unequal treatment of the wealthy vs. poor
• environmental concerns; externalities
• health and safety
externality: costs or benefits that spill-over to a third party
A. Barnaby @ CCC
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THE MODEL OF PURE COMMAND SOCIALISM
…an economic system where the means of production are publicly owned
and the fundamental economic choices are made by the central authority
Basic Elements of Pure Command Socialism
1. Public Ownership of all Means of Production
2.
Centralized Decision Making
• Makes all production and distribution decisions
• Follows-through to ensure that decisions are carried out
3.
Economic Planning
• Central planning board must gather information about existing
production capabilities
• devises a master plan with production outputs for industries
• industries give production outputs to each producing unit
4.
Allocation by Command
• Producing units are told what and how much to produce as well
as resources to use
• Individuals are told where to work and how much of a g/s they
can consume
HOW COMMAND SOCIALISM ANSWERS THE THREE
FUNDAMENTAL QUESTIONS
What to produce, how to produce, and for whom to produce are all
determined by the central planning board.
• They must further ensure that their directives are carried out
• Must produce within their production possibilities
• Cannot produce efficiently or even realistically without a clear
understanding of their resources
• Allocation methods may vary: equality, service, loyalty
A. Barnaby @ CCC
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STRENGTHS AND WEAKNESSES OF PURE COMMAND SOCIALISM
Strengths:
• Greater equality in the distribution of wealth and g/s
• Potential for greater growth and other goals in targeted sectors
Weaknesses:
• Central planning board’s goals may not be those of the society
• Unrealistic amount of information must be acquired and dissimilated
in a short period of time
REAL-WOLD ECONOMIES
Mixed economy: an economy which is a blend of capitalism and command
socialism
e.g. The U.S. Economic System:
Capitalist Aspects
• High degree of private ownership
• Coordinated by the market mechanism
• Buyers and sellers are guided by self-interest
• Profit seeking and competition are evident
Command Socialism Aspects
• Public ownership
e.g. municipal power, public schools and universities, USPS,
public transportation, etc.
• Rules and regulations established, maintained and enforced by
the government
o anti-trust laws to maintain competition
o laws, taxes, subsidies to correct externalities
o g/s which would not or could not be produced privately
such as national defense
o the progressive federal income tax redistributes the
nation’s wealth
o government agencies and policies are designed to watch
and stabilize the economy
o regulating health and safety by banning or restricting
some g/s while mandating others
A. Barnaby @ CCC