Welch & Welch - Economics: Theory and Practice

Chapter 2 – Decision Making & Systems
Seventh Edition
Patrick J. Welch
St. Louis University
Gerry F. Welch
St. Louis Community College
at Meramec
PowerPoint Presentation by:
Dr. Ray Everett
Pima Community College
Copyright © 2004 John Wiley & Sons, Inc. All rights reserved.
Decision Making & Economic Systems
Basic Economic Decisions
Intro. to Economic Systems
Agrarian Economies
Market Economies
Planned Economies
Mixed Economies
Changing Economic Systems
The U.S. Economic System
Historical Highlights of the U.S. Economy
Decision Making & Economic Systems
Chapter Objectives
• To introduce the basic economic choices that must be made in every
society because of scarcity.
• To describe differences among traditional, market, and planned
economies, and how the basic economic choices are made in each of
these systems.
• To explain how market economies are structured and how they
• To explain why, where, and how government intervenes in mixed
economies, chiefly the U.S. economy.
• To distinguish between capitalism and socialism and to describe how
these two systems relate to individual and collective economic
• To discuss economic changes in Eastern Europe.
• To explore the British foundations and the historical highlights of the
U.S. economy.
Basic Economic Decisions
• Basic Economic Decisions
 Three important choices a society makes regarding the
production and distribution of goods and services.
• What goods and services to produce and in what
– Everyone in society has endless wants, but only limited
varieties and amounts of consumer and capital goods can
be produced.
• How to produce these goods and services, or how to use
the economy’s resources?
– Products can be made in a number of different ways.
• Who gets these goods and services?
– Focuses on distribution.
Introduction to Economic Systems
• Economic System
 One of four ways to organize the
relationships among businesses,
households, and the government
within a society.
• Agrarian economies
– Decision making is based on
• Market economies
– Decision making is made by buyers
& sellers through prices in
• Planned economies
– Decision making is a collective
Scarcity, the Basic
Mixed economies
Economic Decisions, and
Economic Systems
– Combine market & planned systems.
Agrarian Economies
• Agrarian Economies
 Also called traditional economies.
 Rely on historical, social, political, or religious
arrangements or tradition to decide what to produce.
 Fairly small, close, and rural, and they often work to
support all members.
 Allocate a larger distribution of goods and services to
those with a defined social status within the society.
Market Economies
• Market Economies
 Also called price systems.
 Rooted in the belief that decisions are best made by
 Private property rights are essential to these systems.
 Ability to engage in
free enterprise, which
is why market
economies are often
associated with
 A pure market
economy can best be
illustrated by using a
circular flow chart.
The Circular Flow of Economic Activity
Market Economies
• Market Economies (cont.)
 Rely on millions of independent decisions by individual
households and businesses in the marketplace to
determine what to produce.
 Comprised of myriad businesses that usually utilize the
least-cost method of production.
 Utilize the price system to determine who receives goods
and services.
• People have access to goods and services only if they can
pay for them, and their ability to pay is determined by the
number and value of resources that they, the people, offer
to businesses.
Market Economies
• Market Economies (cont.)
 Unparalleled opportunity for growth and change.
• Those born into poverty have the ability to transcend that
barrier and ascend the economic ladder.
 Lack of consideration given by some businesses when
profit is a prime motive.
• Can lead to lower costs for businesses, but will lead to
higher costs for society due to hazardous products or poor
working conditions.
Market Economies
• Government Intervention in Market Economies
 Society frequently turns to the government for help when
it wants to address market failures.
 Economies are no longer pure after such intervention.
Government Intervention in a Market Economy
Planned Economies
• Planned Economies
 Also called command economies.
 Rely on planning authorities to decide what to produce.
 Look to planning authorities to instruct enterprises on
how to produce various items.
 Trust in planning authorities to distribute goods and
Mixed Economies
• Mixed Economies
 Economies in which decisions are addressed by some
combination of market and centralized decision making.
 Pure market and pure planned economies are used as a
basis, but neither have real-world counterparts, and
neither are perfect in their design.
 As market economies experience problems, they tend to
move away from pure market to mixed economies, and
as planned economies experience failures, they move
away from pure planned to mixed economies.
Continuum of Economic Decision Making
Changing Economic Systems
• Beginning in the mid-1980s, dramatic changes occurred
in many of the world’s planned economies.
• The Soviet Union, Poland, Hungary, and other nations
began moving toward greater use of free markets and
individual decision making.
• Privatization allowed individuals to be granted property
rights to factors of production that were once collectively
owned, or owned by the state.
• Problems have arisen in the transition from planned
economies to market economies due to economic
problems that defy simple or obvious solutions.
• One lesson learned from these experiences is that,
while the commitment to change may be professed
quickly, change itself comes slowly.
The U.S. Economic System
• The U.S. economy has been described as a mixed
economic system; one that primarily depends on
markets and individual decisions, though some
government intervention is also present.
• It came as a result of the transformation of England and
Scotland into industrial market economies.
• This began with the rise of economic individualism.
• In his book The Wealth of Nations in 1776, Scottish
philosopher Adam Smith proposed a new economic
system called laissez-faire (let it alone) capitalism which
challenged the reigning system of mercantilism in which
the state was deemed to be the best judge of what is
good for an economy.
• Central to Smith’s argument for a new economic system
was his invisible hand doctrine.
The U.S. Economic System
• According to his doctrine, people do not base their
business dealing with others on altruism or
benevolence. Rather, people carry on their business in
a way that serves their own best interests.
• Smith explained that by pursuing one’s own best
interest, one is guided “as if by an invisible hand” to
advance the interests of all society.
• As this philosophy rose, the British world saw significant
technological and social changes that are known today
as the British Industrial Revolution.
• It spurred a series of inventions and innovations such
as massive mechanical weaving looms and steam
• These inventions led to changes in how goods and
services were rendered.
Highlights of the U.S. Economy
• Along with the progress made by England and Scotland
between the 17th and 19th centuries, the evolution of
the U.S. economy was brought about by several key
events in the U.S:
 Prior to the Civil War, the U.S. economy was primarily
agricultural, but following the Civil War substantial and
significant changes occurred due to an industrial boom
experienced throughout the majority of the country.
 With this boom in the economy came regulation of
companies that were becoming large and might be able
to monopolize markets.
 Along with regulation of monopolies, the government
intervened in other problems, such as the harsh living
and working conditions.
 The next round of government interventions would come
in the form of the New Deal.
Highlights of the U.S. Economy
 Due to the stock market crash of 1929 and the following
economic decline, the “New Deal” created a series of
programs and legislative reforms instituted during the
presidential administration of Franklin D. Roosevelt.
 The next big intervention made by the government would
come in the form of the Employment Act of 1946, which
provided Congress with the ability to manipulate taxes
and government spending in an effort to bring the
economy to a desired level of activity.
 Regulatory activities increased in the 1960s and the
1970s, until a deregulation trend developed in the late
1970s and continued in the 1980s as part of the Carter
and Reagan administrations.
 Since the 1980s, the federal debt has risen dramatically.
 By 2003 the debt exceeded $6.5 trillion, and the
regulatory activity trend was once again reversed.
Chapter 2 – Decision Making & Systems
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Seventh Edition
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