“Introduction to Economic Systems”
Critical Questions
• What key economic questions must
every society answer?
• What basic economic goals do societies
have?
• What types of economic systems exist
today?
What is an economic system?
The method used by a
society to produce and
distribute goods and
services
The Three Questions that Determine
a Societies Economic System
Because ALL economic resources are scarce,
every society must answer three questions:
– What goods and services should be
produced?
• Guns or butter?
– How should these goods and
services be produced?
• What combination of factor resources
should we use?
– Who consumes these goods and
services?
• How will income be distributed?
• Every society has some system or mechanism
that transforms that society’s scarce resources
into useful goods and services.
Four Economic Systems
An economic system is the method used by a society
to produce and distribute goods and services.
Traditional economies rely
on habit, custom, or ritual to
decide what to produce,
how to produce it, and to
whom to distribute it.
In a market economy
economic decisions are
made by individuals and
are based on exchange, or
trade.
In a centrally planned
economy the central
government makes all
decisions about the
production and
consumption of goods and
services.
Mixed economies are
systems that combine
tradition and the free
market with limited
government intervention.
Comparing Economic Systems
Economic System
Who answers the 3 ?’s
•
•
•
•
•
•
•
•
Traditional
Market
Command
Mixed
Customs
Individuals
Central Government
Individuals with some
government
involvement
Traditional System
• A traditional system relies on habit,
custom or ritual to decide what to
produce, how to produce it and to
who to distribute it.
• Agricultural and hunting societies
• There is little room for innovation or
change.
• They tend to lack modern conveniences
and have a low standard of living.
• Close knit communities with focus on the
family unit.
Traditional Economy
• Found in rural, underdeveloped countries–
–
–
–
–
Vanuatu
Pygmies of Congo
Eskimos & Indian tribes
Belarus
• Customs govern the
economic decisions that
are made
• Farming, hunting and
gathering are done the
same way as the
generation before
• Economic activities are
centered around the family
or ethnic unit
• Men and women are given
different economic roles
and tasks
• Advantages: people have
specific roles; security in
the way things are done
• Disadvantages: Technology
is not used; difficult to
improve
Why Do Markets Exist?
Markets exist because none of us produces
all the goods and services we require to
satisfy our needs and wants.
A market is an
arrangement that
allows buyers and
sellers to
exchange goods
and services.
Specialization is the
concentration of the
productive efforts of
individuals and
firms on a limited
number of activities.
Free Markets
Circular Flow Diagram of a Market Economy
• In a free market
economy, households
and business firms use
markets to exchange
money and
products.
Households
• Households
own the factors
of production
and consume goods and
services.
monetary flow
physical flow
Firms
physical flow
monetary flow
Advantages of the
Economic Efficiency
Market
•
As a self-regulating
system, a free
market economy is
efficient.
Economic Growth
• Because
competition
encourages
innovation, free
markets encourage
growth.
Economic Freedom
• Free market economies
have the highest degree of
economic freedom of any
economic system.
Additional Goals
• Free markets offer a
wider variety of goods
and services than any
other economic system.
Market Economy (Free Enterprise)
• Supply and demand of
• Also called a Free Market
goods and services
Economy or Free Enterprise
determine what is produced
Economy
and the price that will be
• Businesses and consumers
charged.
decide what they will
produce and purchase and in • Advantage—competition to
have the best products and
what quantities
services
• Decisions are made
according to law of supply • Disadvantage—huge rift
between wealthy and poor
& demand
• Note: a true market
economy does not exist.
Command Economies
The
government,or
central authority
controls the
economy.
Organization of Command Economies
In a command economy, the government
owns both land and capital. The government
decides what to produce, how much to produce,
and how much to charge.
Socialism is a social
and political philosophy
based on the belief
that democratic means
should be used to
distribute wealth
evenly throughout a
society.
Communism is a political
system characterized by a
centrally planned economy
with all economic and
political power resting in the
hands of the government.
Communist governments are
authoritarian in nature.
Command Economy
• The government (or central
authority) determines what,
how, and for whom goods
and services are produced.
• Two types:
• Advantages
– Guarantees equal standard
of living for everyone
– Less crime and poverty
– Needs are provided for
through the government
– Strong Command – where
government makes all
• Disadvantages
decisions (communism –
– Minimal choices
China, Cuba)
– Fewer choices of items
– Moderate Command – where
– No incentive to produce
some form of private
better product or engage in
enterprise exists but the state
entrepreneurship
owns major resources
(socialism – France and
•
Also
known
as
a
Planned
or
Sweden)
Managed Economy
The Soviet Experiment
• Land, labor and capital was all controlled by
the state. The best resources were allocated to
to the armed forces, space program, and
production of capital goods.
• Government committees decided the quantity,
process and distribution of all products.
• The government created large state-owned
farms and collectives to produce all agricultural
products.
• Under this system there was little incentive to
produce, and the Soviet Union saw a rapid
decline in the production of agricultural goods.
The Meaning Behind the Flag
The hammer and sickle originate
from the unique Russian unity of the
peasants (the sickle) with the workers
(the hammer) who together formed
the Soviet Russian state.
• The Red field is symbolism of the blood that has
been spilt by workers the world over in the fight for
their emancipation.
• The single yellow star is the representation of the
life and immense energy of the sun, empty because
within is the blood or production of workers
struggle.
Command economy face
problems of poor-quality
goods, shortages, and
diminishing production.
Other Problems in Centrally
Planned Economies
•
•
•
•
•
Performance falls short of the set ideals
Fail to meet consumer needs and wants
Little individual incentives to work hard
Lack of improvement
Expensive and inflexible government
structure needed to manage the system
• Sacrifice of individual freedoms to
pursue societal goals
Mixed Economies
• It is doubtable that any
nation can exist
successfully under a pure
command economy or a pure
market economy.
• Most economies mix features of
both systems.
Mixed Economy
• Most nations have a
• Combination of a
market and a
command economy
• Government takes
of people’s needs
• Marketplace takes
care of people’s
wants.
mixed economy: United
States, England,
Australia
• Advantage —balance of
needs and wants met by
government and in
marketplace
• Disadvantage —citizens
have to pay taxes
An economic system that permits the conduct of business with minimal
government intervention is called free enterprise. The degree of
government involvement in the economy varies among nations.
Nations are placed on a continuum (a range with no clear divisions) of
mixed economies. On one end are centrally planned economies and
on the opposite end are free markets economies.
Continuum of Mixed Economies
Centrally planned
Free market
Iran
North Korea
Cuba
South Africa
China
Russia
France
Botswana
Greece
United Kingdom
Canada
Peru
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
Hong Kong
Singapore
United States
Comparing Mixed Economies