Economic Systems and the
American Economy
Chapter 2
Economic Systems
Chapter 2, Section 1
Economic Systems
 Economic System: The way that a society uses its
resources to satisfy the wants and needs of the people
 Each economic system address THREE questions:
 WHAT should be produced?
 HOW should it be produced?
 FOR WHOM should it be produced?
 FOUR economic systems:




Traditional economy
Command economy
Market economy
Mixed economy
Traditional Economy
 Traditional Economy: system in which economic decisions are based on
customs and beliefs that have been handed down generation to generation.
 Decisions are made according to historical patterns.
 Your job is learned from your parents.
 Advantages:


Family and community ties are strong.
Roles are clearly defined.
 Disadvantages:



Change is discouraged, so methods of production are often inefficient.
Choice of consumer goods is limited.
Standard of living does not increase over time or generation to generation.
 Examples: tribal communities such as the Inuit of North American or the
Aborigines of Australia
Command Economy
 Command Economy: System in which the governments controls the factors
of production and makes all decisions about their use.
 Economic decisions are made by the leader of the country, a small group of
leaders or a group of central planners.
 Workers may not get to choose their own job.
 Workers are paid according to what the central government decides.
 Disadvantages:



No incentive to work hard or show inventiveness as you cannot get ahead.
Without inventiveness, production is inefficient.
Limited consumer choices
 This is the type of economy in communist (and some socialist) countries.
 Example: North Korea, the former Soviet Union
Market Economy
 Market Economy: system in which individuals own the factors of production
and make decisions about their use
 A market economy is a capitalist system.
 The role of government is limited – allowing individuals to make the economic
decisions (three questions).
 Advantages:



Freedom – free to choose your job and how to spend your money, free to own
property, free to start a business and earn profits
Efficient production since individuals are rewarded for ingenuity and hard work
Many consumer choices
 Disadvantages:

Individuals must sell their labor to survive – individuals who cannot or will not work
cannot survive in this economy.
Market Economy (continued)
 Market Economy: system in which individuals own the
factors of production and make decisions about their
use
 Market: The process of freely exchanging goods and
services between buyers and sellers.
 This exchange is driven by prices.
 This is the opposite of a command economy.
 Example: There are no pure market economies. The
US is primarily a market economy but not purely.
Market Economy (continued)
 Circular Flow of Income and Output: economic
model that pictures income as flowing continuously
between businesses and consumers
Mixed Economy
 Mixed Economy: system combining characteristics of more than one
type of economy.
 Most mixed economies are a combination of command and market
economies.
 Private ownership of property and individual decision making are
combined with government intervention and regulation.
 Examples of government involvement in mixed economies:
 Government consumes and produces goods (military, roads, schools)
 Government may own some factors of production (such as natural
resources)
 Transfer programs – taking taxes from some citizens and giving the
money to the poor, elderly or disabled (welfare, medicaid)
 Example: The US is a mixed economy – it is a combination of market
and command economies
Characteristics of the
American Economy
Chapter 2, Section 2
The Limited Role of Government in the
American Economy
 America is capitalist – an economic system in which private individuals own
the factors of production.
 Laissez-faire: a French term “let the people do as they choose” It refers to a
pure capitalist system.
 In America, individuals own the factors of production but use them within
certain legislated limits.
 The role of the government in our economy is limited but has grown over the
last 100 years.
 Federal agencies regulate the quality of food and drugs
 Federal government oversees the nation’s banking system
 Government inspects workplaces for hazardous conditions
 Government guards against damage to the environment
 Government uses tax revenues to provide social programs to the elderly, poor and

disabled
State and local governments regulate education
Characteristics of the
American Economy
 Limited Role of Government
 Freedom of Enterprise – Individuals are free to own the factors of
production and decide how to use them within legal limits.
 Free-enterprise system = capitalism = market economy
 Freedom of Choice – Buyers decide what will be produced based on
buying or not buying a certain product.
 Profit Incentive – The desire to make a profit that motivates people
to produce goods and services.
 Profit: Business revenues minus costs
 Competition – rivalry among producers of similar goods and services
to win more business.
 Private Property – Property can be owned by individuals or groups of
individuals rather than by the government.
Goals of a Nation
Chapter 2, Section 3
Remember…
Free-Enterprise System = Capitalism = Market Economy
 The US is a technically a mixed economy but it is much
more market economy and less command economy
Goals of Free-Enterprise
 Freedom – Individuals have choices: what to buy, what to produce,
what to own, what to do for a living, how much to work.
 With freedom come costs – if you start a business that fails, the
government usually won’t help you.
 Economic Efficiency – wise use of scarce resources to obtain the
greatest possible benefit
 If we waste resources, we won’t have as many goods.
 Economic Equity – the attempt to balance economic policy so that
everyone benefits fairly.
 Equal pay for equal work, fairness in hiring
 Economic Security – protection against risks beyond our control
(accident at work, bank failure, natural disasters, poverty in old age)
Goals of Free-Enterprise
(continued)…
 Economic Stability – reducing extreme ups and down
in our standard of living: material well-being of a
person, group or nation measured by how well their
necessities and luxuries are satisfied.
 Economic Growth – expansion of the economy to
produce more goods, jobs and wealth.
Rights and Responsibilities in
Free Enterprise
Rights
 Enter any profession or
business you choose
 Work very little or even be a
“workaholic”
 Buy whatever products and
brands you choose
Responsibilities
 Support yourself and your
family
 Use you education to
become a productive
member of society
 Elect responsible
government officials – this
means having knowledge of
government policies and
being able to analyze those
policies
Socialism and
Capitalism
Chapter 2, Section 4
Socialism
 Pure Command Socialism: a system in which the
government owns the major factors of production and
attempts to manage output and the distribution of
goods
 There are few examples of this: North Korea and Cuba
and the former Soviet Union
Socialism
 Marxian View of Socialism: Marx’s view is that capitalists
(owners of businesses) exploit workers. He believed that since the
workers made the goods, the workers should get the profits, not
the owners.
 Marx believed that capitalism would make the workers poor and
the workers would rise up and overthrow capitalism. Then the
government would own the factors of production, creating
socialism.
 Marx also believed that socialism would evolve into communism:
an idealized society where there is no government; “society” not
individuals would own the factors of production.
 This exists nowhere today
 In reality, communist countries have very powerful central
governments, not “no government”.
Socialism
In the 20th century, two types of socialism developed:
 Democratic Socialism: system that works within a
constitutional framework of a nation to elect socialists to
office; the government usually controls only some areas of
the economy.
 Many countries have this system.
 Authoritarian Socialism: system that supports revolution
as a means to overthrow capitalism and bring about socialist
goals. The entire economy is controlled by a central
government – also called communism.
 Examples: North Korea, Cuba, the former Soviet Union.
Criticisms of Socialism
 Government interference in the economy
 Limited personal freedoms
 Low production efficiency
 Slow rate of economic growth
Capitalism
Benefits
 Freedom
 Better efficiency
 Higher rates of economic
growth
 Planning is shared by
individuals, businesses and
government
Criticisms
 Not all people have the same
income level
 Government does not
provide enough services for
people