Ch. 2 Economic Systems
Section 1
Answering the Three
Economic Questions
Economic Systems
• Scarcity forces societies to answer some key
economic questions about how to use available
resources.
• An Economic system is the method used by a
nation to produce and distribute goods and
services.
Three Key Economic Questions
• What goods and services should be produced?
– 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?
• How should these goods and services be
produced?
– Should we produce electricity with oil, solar power, water power, or
nuclear power?
– Should we produce food on large corporate farms or family farms?
• Who consumes these goods and services?
– How is what is produced divided among population? By income?
By need? By status?
Answers to the Questions
• Because every nation has its own unique set of
resources, goals, and values, they will answer the
questions in a different way.
Economic Goals
• The general economic goals and societal values that most
economic system tries to address are:
–
–
–
–
–
Economic Efficiency
Economic Freedom
Economic Security and Predictability
Economic Equity
Economic Growth and Innovation
Economic Efficiency
• Because resources are always scarce, most societies try to
maximize what they can get for the resources they have to
work with.
• If a society can accurately assess what to produce, economic
efficiency is increased. If not, resources are wasted.
• Products also need to reach consumers. An economy that can’t
deliver goods isn’t efficient.
Economic Freedom
• Most of us value the opportunity to make our own choices. We are limited
to some extent by laws that forbid purchasing or possessing certain items.
• In the U.S., the economic freedoms that we enjoy are an important reason
for our patriotism.
• Patriotism is the love of our country that inspires us to defend it from
invasion or protect its rights and maintain its laws and institutions.
• Freedom is what our country was built on.
Economic Security and Predictability
• Most people don’t like uncertainty. We want assurances that:
– Goods and services will be available.
– Payments will be made on time.
– A safety net will protect individuals in times of economic disaster.
• Most countries also believe in providing some sort of base
income for retired people to ensure they can support
themselves after retirement.
Economic Equity
• Each society must decide the best way to divide its
economic pie, or how should it fairly distribute its
wealth.
– What constitutes a fair share? Should everyone get the same or should
it depend on how much one produces?
– How much should society provide for those who are unable or
unwilling to produce?
– How should we provide for the ill and infirm?
Economic Growth and Innovation
• An economy must grow for a nation to improve its standard of
living, or level of economic prosperity. This must happen to
provide new jobs and income for a growing population
• Innovation causes this economic growth. Innovations in
technology increase the efficiency of production.
• Greater efficiency leads to economic growth, resulting in a
higher standard of living.
Goals and Trade-offs
• All nations must prioritize their economic goals,
arranging them in order of importance to them.
• Regardless how they are prioritized, one fact remains:
–
achieving any economic goal comes only with some kind of economic
tradeoff.
Economies and Values
• Four different economic systems have developed
to address the three key economic questions.
• Each system reflects a different prioritization of
economic goals.
• It also reflects the values of the societies in which
these systems are present.
Traditional Economies
• Relies on habit, custom, or ritual determine the
answers to the three key economic questions as well
as social norms.
• There is little room for innovation or change.
• This system revolves around the family, with work
being divided along gender lines.
• They support and provide for one another, not just
for themselves or immediate family.
Traditional Economies
• Agriculture and hunting practices lie at the heart of
their lives, laws, and religious beliefs.
• They lack modern conveniences and have a low
standard of living.
• They resist change and are slow to adopt new
technology or radical new ideas. Change they feel is
a threat to their very existence.
Market Economies
• Individuals make decisions based on trade that
occurs in markets.
• These choices determine what gets made and who
consumes goods and services.
• Market economies are also called free markets, or
capitalism.
• We will discuss free markets in detail in Section 2
Centrally Planned Economies
• The central government makes all decisions regarding
production and consumption of goods and services.
• Also known as command economies, because a
central authority is in command of the economy.
• We will discuss centrally planned economies in detail
in Section 3.
Mixed Economies
• These are market-based systems in which government
plays a limited role.
• Combine elements of traditional, market, and
centrally planned economies.
Ch. 2 Economic Systems
Section 2
The Free Market
Markets
• A market is an arrangement that allows buyers and
sellers to exchange things.
• Markets exist because no one is self-sufficient.
• None of us produce all we require to satisfy our
needs and wants, so we specialize.
• Specialization makes us more efficient.
• Because of specialization, we need markets to
exchange money, resources, and products.
Free Market Economy
• Factors of production are privately owned.
• Businesses are privately owned.
• Individuals buy what they want by interacting with
sellers.
• Businesses sell what they want by interacting with
buyers.
• In other words, buyers and sellers answer the three
key economic questions of what, how, and who.
Free Market Economy Illustrated
• Circular flow diagram – illustrates the exchange of money,
resources, and products in a free market economy.
Circular Flow Model Video
• The Circular Flow Model of a Market
Economy
Keeping the Market Economy Flowing
• Producers and consumers acting in their own selfinterest “motivate” the market.
• Competition among producers and consumers help
“regulate” the market.
• A market economy operates without any
interference or direction.
Advantages of the Free Market
• Free markets are efficient because they are self
regulating.
– They are able to respond efficiently to rapidly changing
conditions.
• Free markets encourage economic growth.
– Entrepreneurs are always seeking profitable
opportunities, contributing new ideas and innovation
Advantages of the Free Market
• Free markets have a high degree of economic
freedom.
– Workers work where they want, firms are able to
produce what they want, and individuals consume what
they want.
• Free markets offer a wider variety of goods and
services than other systems.
–
Producers have incentives to meet consumers’ desires.
Consumers basically decide what gets produced
(consumer sovereignty)
Economics Ch. 2
Economic Systems
Section 4
Modern Economies
Mixed Economies
• No single economic system has all the answers, so
mixed economies developed
• Early economists believed that allowing markets to
operate freely without any government involvement
(laissez faire) would provide the greatest benefit for
consumers.
• Others believe that there is a need for a certain
limited degree of government intervention in the
economy.
Governments Role as a Consumer
• Purchases land, labor, and capital from households in
the factor market.
• Purchases goods and services from firms in the product
market.
Governments Role as a Producer
• Produces goods and services through the factor
resources that they combine.
• Example:
– Public Transportation
– Libraries
– Schools
– Police/Fire Protection
– National Defense
Governments Role in Transferring
Money
• Collects taxes from both households and businesses.
• Transfers the money they collect for a number of
reasons:
– Social Security
– Worker disability
– Unemployment
– Survival of an Industry
Writing Assignment
write a 5 paragraph essay on the following:
• Writing Prompt;
– Describe the role that you, an individual
citizen, would play in each of the three
economic systems that we discussed.
Circular Flow Diagram Exercise
• Follow the instructions provided to
complete the handout.