Chapter 2 – Economic Systems
• Section 1 – Answering economic Questions
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The Three Economic Questions
• Every society must answer three questions:
– What goods and services should be produced?
– How should these goods and services be produced?
– Who consumes these goods and services?
• How a society answers these questions depends on
how it values different economic goals.
• As a result, four different economic systems have
developed in response to these three questions.
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What goods and services should be produced?
• Each society must decide
what to produce in order to
satisfy its needs and wants.
• Often difficult to distinguish
wants and needs
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Critical questions arise:
• How much of our resources
should we devote to national
defense, education, public
health and welfare, or
consumer goods?
• Which consumer goods
should we produce?
• Because of limited resources,
each decision a society makes
comes at an opportunity cost.
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How should these goods and services be
produced?
•
How do we use our RESOURCES
to produce goods and services?
–Electricity with oil, solar or
nuclear energy?
–Classes with 20 or 30
students?
–Corporate farms vs. family
farms?
•
Countless ways to produce all
things we want and need
–All require land, labor, capital
•
Must determine these factors of
production and the best way to
use them to maximize efficiency
on production possibilities curve
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Who consumes these goods and services?
• Societies must decide how to
distribute the available goods
and services.
• Who gets:
–Luxury car vs. bus ticket?
–Concert tickets vs stay
home?
–Well balanced diet vs hot
dogs every meal?
• Answer is determined how
societies choose to distribute
income.
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Factor Payments
•
The income people receive for
supplying factors of production –
land, labor, capital…or
entrepreneurship
•
Simply put: how much money
you make for the work you do.
•
Landowners – rent
•
Workers – wages
•
Lenders – interest
•
Entrepreneurs – profits (hopefully)
• How much we pay the owners
of the factors of production is
determined by each society
based on its own unique
combination of social values
and goals.
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Societies answer the three economic questions
based on their values.
Economic Goals
Economic efficiency
Economic freedom
Making the most of resources – societies try to maximize what
they can get for the resources they a have to work with
Freedom from government intervention in the production and
distribution of goods and services. The economic systems of
different nations allow different degrees of economic freedoms.
People all over the world face limitations on economic freedoms.
predictability
Assurance that goods and services will be available, payments will
be made on time, and a safety net will protect individuals in times
of economic disaster. Ex: milk & bread at the store; paychecks on
time; SAFETY NET for natural disasters, job loss, injuries provided
by govt to protect people; base income for retired & elderly so they
can support themselves
Economic equity
Fair distribution of wealth. Most societies believe in equal pay for equal
work but society does not value all jobs equally. All not able to work.
Economic security and
Economic growth and
innovation
Other goals
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Innovation leads to economic growth, and economic growth leads to
a higher standard of living. Economy must grow to provide new jobs
and income for people. Innovation in technology increases efficiency
of production & usher in new goods and services.
Societies pursue additional goals, such as environmental
protection, full employment, universal healthcare. Nations must
prioritize inMain
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of importance. Achieving any goal comes with
some kind of trade-off.
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
(command) 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.
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TRADITIONAL
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Little room for innovation/change
Revolves around the family
Work divided along gender lines – boys
tend to follow father’s occupation; girls
follow in mother’s footsteps
Relatively small, close communities (think
villages)
Often work to support entire ethnic group
rather than just themselves or immediate
family
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TRADITIONAL
•
•
•
Few mechanisms in place to deal with environmental disaster
Tends to remain stagnant, resisting change at both individual and
community level
May not have access to goods and services
•
•
•
•
•
(ie no grocery stores or department stores)
People make their clothes, tools, homes…
Communities lack modern conveniences & low standard of living
Found primarily in rural, non-industrial areas
Examples: areas of Africa, South America, Asia, Middle East
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Section 1 Assessment
1. Each society determines who will consume what is produced based on
(a) its unique combination of social values and goals.
(b) the amount of factor payments.
(c) its needs and wants.
(d) economic equity.
2. To improve its standard of living, a nation’s economy must
(a) remain stable.
(b) grow through innovation.
(c) reach economic equity.
(d) allow the central government to make economic decisions.
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Section 1 Assessment
1. Each society determines who will consume what is produced based on
(a) its unique combination of social values and goals.
(b) the amount of factor payments.
(c) its needs and wants.
(d) economic equity.
2. To improve its standard of living, a nation’s economy must
(a) remain stable.
(b) grow through innovation.
(c) reach economic equity.
(d) allow the central government to make economic decisions.
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Chapter 2 – Economic Systems
• Section 2 – The Free Market
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The Free Market
• How do free markets operate?
• How can markets regulate themselves?
• What are the advantages of a free market economy?
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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.
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Specialization is the concentration
of the productive efforts of
individuals and firms on a limited
number of activities.
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The Free Market Economy
•
In a free market economy,
households and business
firms use markets to
exchange money and
products. Households own
the factors of production
and consume goods and
services.
Circular Flow Diagram of a Market Economy
Households pay
firms for goods
and services.
Product market
monetary flow
physical flow
Firms supply
households with
goods and services.
Households
Households supply
firms with land, labor,
and capital.
Firms
physical flow
monetary flow
Factor market
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Firms pay
households for land,
labor, and capital.
The Market’s Self-Regulating Nature
• In every transaction, the buyer and seller consider only
their self-interest, or their own personal gain. Selfinterest is the motivating force in the free market.
• Producers in a free market struggle for the dollars of
consumers. This is known as competition, and is the
regulating force of the free market.
• The interaction of buyers and sellers, motivated by selfinterest and regulated by competition, all happens
without a central plan. This phenomenon is called “the
invisible hand of the marketplace.”
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Advantages of the Free Market
Economic Efficiency
Economic Freedom
• As a self-regulating system, a
free market economy is
efficient.
• Free market economies have
the highest degree of
economic freedom of any
economic system.
Economic Growth
• Because competition
encourages innovation, free
markets encourage growth.
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Additional Goals
• Free markets offer a wider
variety of goods and services
than any other economic
system.
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Free Market Economy
• Private ownership of
property and
resources
• Profit
• Competition
• Consumer
sovereignty
• Individual choice
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Free Market Economy
• Private ownership of
property and
resources
• Profit
• Competition
• Consumer
sovereignty
• Individual choice
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Profit
• consists of earnings
after all expenses
have been paid
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competition
• rivalry between
producers/sellers
of a good or
service results in
better quality
goods and
services at a
lower price
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Consumer sovereignty
• Consumers
determine
prices through
purchases, what
goods and
services will be
produced
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FREE MARKET
1. Individual consumers make
decisions according to supply and
demand
2. People are free to buy, sell, and
produce whatever they want,
whenever they want, and any way
they want
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FREE MARKET
3. People can work wherever they
want
4. Capitalism is another name for
market economies
5. People enjoy a free enterprise
system
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Section 2 Assessment
1. Why do people need to buy and sell goods or services?
(a) People need to buy and sell goods to make a profit.
(b) People buy and sell to maintain a competitive society.
(c) No one is self-sufficient.
(d) People need to provide the market with goods and services.
2. What factors create the phenomenon of the “invisible hand”?
(a) incentives and efficiency
(b) specialization and efficiency
(c) competition between firms
(d) competition and self-interest
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Section 2 Assessment
1. Why do people need to buy and sell goods or services?
(a) People need to buy and sell goods to make a profit.
(b) People buy and sell to maintain a competitive society.
(c) No one is self-sufficient.
(d) People need to provide the market with goods and services.
2. What factors create the phenomenon of the “invisible hand”?
(a) incentives and efficiency
(b) specialization and efficiency
(c) competition between firms
(d) competition and self-interest
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Chapter 2 – Economic Systems
• Section 3 – Centrally Planned Economies
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Centrally Planned Economies
• How are centrally planned economies organized?
• How did the centrally planned economy of the former
Soviet Union function?
• What problems exist within centrally planned
economies?
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Organization of Centrally
Planned Economies
In a centrally planned 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.
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Communism is a political system
characterized by a centrally planned
economy with all economic and
political power resting in the hands
of the government.
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The Former Soviet Union
• Soviet Agriculture
– In the Soviet Union, the government created large state-owned
farms and collectives for most of the country’s agricultural
production.
• Soviet Industry
– Soviet planners favored heavy-industry production (such as
steel and machinery), over the production of consumer goods.
• Soviet Consumers
– Consumer goods in the Soviet Union were scarce and usually
of poor quality.
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Problems of a Centrally Planned Economy
Centrally planned economies face problems of poorquality goods, shortages, and diminishing production.
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Command Economy
• Central
ownership of
property and
resources
• Centrally planned
economy
• Lack of
consumer choice
China
Cuba
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Command Economy
1. Government decides what
products to make, how many to
make, how to make them, and
who gets them
2. Government controls factories,
farms, natural resources,
transportation systems, and stores
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Command Economy
3. Individual has little or no say
4. Soviet Union used to have this
type of economy
5. There is no competition
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Section 3 Assessment
1. In a socialist country,
(a) central planning is unnecessary.
(b) the government often owns major industries, such as utilities.
(c) an authoritarian government controls the economy.
(d) economic equality is not important.
2. Which of the following is an advantage of a centrally planned economy?
(a) the system’s bureaucracies are small and flexible
(b) the system can work quickly to accomplish specific goals
(c) innovation is well rewarded
(d) consumers’ needs are well met
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Section 3 Assessment
1. In a socialist country,
(a) central planning is unnecessary.
(b) the government often owns major industries, such as utilities.
(c) an authoritarian government controls the economy.
(d) economic equality is not important.
2. Which of the following is an advantage of a centrally planned economy?
(a) the system’s bureaucracies are small and flexible
(b) the system can work quickly to accomplish specific goals
(c) innovation is well rewarded
(d) consumers’ needs are well met
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Chapter 2 – Economic Systems
• Section 4 – Modern Economies
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Modern Economies
• Why are many modern economies mixed economies?
• What role does the government play in a mixed
economy?
• How do mixed economies in different countries
compare?
• What role does free enterprise play in the United States
economy?
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The Rise of Mixed Economies
Market economies, with all their advantages, have
certain drawbacks.
Limits of Laissez Faire
Laissez faire is the doctrine that
government generally should not
interfere in the marketplace.
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Governments create laws
protecting property rights and
enforcing contracts. They also
encourage innovation through
patent laws.
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Government’s Role in a Mixed Economy
In a mixed economy,
Circular Flow Diagram of a Mixed Economy
Product market
• The government
purchases land, labor,
and capital from
households in the
factor market, and
• Purchases goods and
services in the product
market.
monetary flow
physical flow
Households
expenditures
Government
physical flow
monetary flow
Factor market
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expenditures
Firms
Comparing Mixed Economies
• 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.
Continuum of Mixed Economies
Centrally planned
Free market
Iran
North Korea
South Africa
China
Cuba
Russia
France
Botswana
Greece
United Kingdom
Canada
Peru
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
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Hong Kong
Singapore
United States
Mixed economy
• Individuals and businesses as
decision makers for the
private sector
• Government as decision
maker for the public sector
• Greater govt role than in free
market economy
• Most economic systems today
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MIXED
1. Individuals and government share
the decision-making process
2. Businesses are usually privately
owned
3. Most efficient way of providing
consumers with goods and
services
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MIXED
4. Various agencies regulate
businesses to ensure that they sell
safe products, that they do not
pollute the environment, and that
they do not cheat consumers
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Section 4 Assessment
1. The United States economy is a mixed economy
(a) based on the principle of a traditional economy, but allows some government
intervention.
(b) based on the principles of a centrally planned economy, with limited
government intervention.
(c) based on the principles of the free market, and allows no government
intervention.
(d) based on the principles of the free market, but allows some government
intervention.
2. Government intervention in a modern economy is useful because
(a) the needs and wants of modern society are always met by the marketplace.
(b) the marketplace has many incentives to create public goods such as parks and
libraries.
(c) governments are able to provide some goods and services that the
marketplace has no incentive to produce.
(d) the marketplace provides all of its own laws.
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Section 4 Assessment
1. The United States economy is a mixed economy
(a) based on the principle of a traditional economy, but allows some government
intervention.
(b) based on the principles of a centrally planned economy, with limited
government intervention.
(c) based on the principles of the free market, and allows no government
intervention.
(d) based on the principles of the free market, but allows some government
intervention.
2. Government intervention in a modern economy is useful because
(a) the needs and wants of modern society are always met by the marketplace.
(b) the marketplace has many incentives to create public goods such as parks and
libraries.
(c) governments are able to provide some goods and services that the
marketplace has no incentive to produce.
(d) the marketplace provides all of its own laws.
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