Chapter 2: Economic Systems
1.
2.
3.
4.
Answering three Economic Questions?
The Free Market
Centrally Planned Economics
Mixed Economics
Command, or Central
Authority Economy
Free Market Economy
Market Allocation
Mixed Economy
Government Allocation
1. Answering three Economic
Questions
WHAT?
HOW?
WHO?
Goods and Services
• What goods and services should be
produced?
• How should these goods and services be
produced?
• Who consumes these goods and services?
. . . Because resources are scarce
Economic System
• The structure of methods and principles a society
uses to produce and distribute goods and services
• A way a society answers these questions defines its
economic system
Economic Goals and Societal
Values
• Different societies answer the
questions based on importance they
attach to various economic goals
Economic Goals
• Efficiency-Societies try to maximize their
resources
• Freedom-the opportunity to make your own
choices
• Security-”Safety net”-programs that protect
people who face unfavorable economic
conditions
• Equity-How should we divide the pie?
• Growth-innovation plays a huge role in
economic growth
Traditional Economies
• An Economic system that relied on
habit, custom, or ritual to decide the
three economic questions.
• There is little room for innovation or
change in traditional economies
• Led to more modern economic systems
Three Economic Systems
• Dominates the modern world
• The free market economy (capitalism)
• The centrally planned economy
(communism) (socialism)
• The mixed economy –a little of both
Differing Systems
• The United States
• Freedom
• Security
• Efficiency
• Equity
• Growth
• The Soviet Union
• Equity
• Growth
• Security
• Efficiency
• Freedom
2. The Free Market
• Economic Freedom -highly valued by
American Society
• Markets -any arrangement that allows
buyers and sellers to exchange things
• We are not producers of all our wants
• Examples – fishing market, farmers
market, Sporting goods store, New York
Stock Exchange Market
Why Markets Exist
• Specialization -concentration of the
productive efforts of individuals and
businesses on a limited number of
activities
• Buying and Selling -sell what we produce
and buy what we want
Free Market Economy
• An economic system in which decisions
on the three key economic questions are
based on voluntary exchange in markets
• Individuals make their own decisions
• Capitalism -the capital that
entrepreneurs invest in businesses are
vital
• Individuals and businesses own the
factors of production
The United States Economy
• Free enterprise economy -private or
corporate ownership of capital goods
• Government of the U.S. plays a major
role in the economy
• “promote the general welfare”
• Some people think that the government
intervenes too much in the economy
• What do you think?
Households and Firms
• Household -person or group of people
living in a single residence
• Firm - business or an organization that
uses resources to produce a product,
which it then sells
Factor and Product Markets
• Factor Market -the arena of exchange
in which firms purchase the factors of
productions from households
• Product Market -the arena of exchange
in which households purchase goods and
services from firms
Circular Flow Model
Product Flow
Product Market
Monetary Flow
Factor Market
Land
Labor
Product Flow
Capital
Factor Market
Monetary Flow
Product Market
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The Self-Regulating Nature of
the Marketplace
• Self Interest -an individual’s own
personal gain
• Incentive -the 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
• The Invisible hand-Adam Smith-the
self regulating nature of the market
place
•
“Give me that which I want, and you shall have this which
you want . . . . It is in this manner that we obtain from one
another the far greater part of those good [services]
which we stand in need of. It is not from the benevolence
of the butcher, the brewer, or that baker that we expect
our dinner, but from their regard to their own interest.” –
Adam Smith, The Wealth of Nations
Adam Smith
Advantages of the Free
Market
• Efficiency -produce what consumers
want
• Freedom -work where you want, produce
what you want, consume what you want
• Growth -innovations
• Consumer Sovereignty - having the
power to decide
And here are some
disadvantages of
the free market
economy, or
capitalism
3. Centrally Planned Economics
• How Central Planning Works
• Government makes all the decisions on
three questions (command economy)
• Government owns all factors of
production
• Direct contrast to free market
structure
Socialism and Communism
• Socialism – range of economic and social systems based on belief
that wealth should be distributed evenly throughout a society
• Communism- political system in which government owns all
resources and means of production and makes all economic
decisions
• “Capitalist production . . . Develops technology and the combining
together of various processes . . . Only by sapping the original
sources of all wealth- the soil and the laborer.” – Karl Marx, The
Communist Manifesto
• All my hard work and all the money
ends up in the hands of capitalists
Authoritarian
• Form of government that limits
individual freedoms and requires strict
obedience from its citizens
• Communist governments are always
authoritarian
Three Communist Economies
• The Soviet Union -1917-Bolshevik RevolutionJoseph Stalin-broke up in 1991
• China - 1949 to late 1970’s-government
planners controlled all aspects of Chinese
society; adopted some free market
• Cuba – Fidel Castro – 1959 – Cuban Revolution
Disadvantages of Centrally
Planned Economies
•
•
•
•
Efficiency -no incentive to work hard
Freedom -discourages competition
Growth -no innovation no growth
Equity -human intuition prohibits equity
The need to satisfy all wants and needs
4 Mixed Economies
• Reasons for Government Involvement
• Laissez-faire -government generally
should not intervene in the marketplace
• Private Property -property owned by
individuals not the government
• Mixed economy -market-based
economics in which government is
involved to some extent
Government in Market
• Factor Market -government instead of
individual owns factors of production
Product Market -government purchases
all goods and services and provides them
the public
Greatest Expenditure in U.S. Government
– Social Security
Factor Market
Monetary Flow
Product Market
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Continuum of Mixed Economies
Central
Planned
North Korea
Cuba
Iran,
Russia
Mixed
Mexico,
France,
South Africa
China Germany
Japan, Poland
Free Market
United States
United
Kingdom
Canada
Hong Kong