© 2007 Thomson South-Western
Economic Systems
© 2007 Thomson South-Western
What is an Economic System?
• It’s the method used by society to produce
goods and services
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The Four Economic Systems
•
•
•
•
Traditional Economy
Market Economy
Planned/Command Economy
Mixed Economy
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Traditional Economy
• Relies on habit, custom, or ritual to make
economic decision
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Market Economy
• Consumers and producers make the economic
decisions
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Planned/Command Economy
• The government makes all of the economic
decisions
“We’ll fulfill five-year plan in four years!”
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Mixed Economy
• Economic decisions are made by both the
government and consumers/producers.
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Economic Models
© 2007 Thomson South-Western
Economic Models
• Economists use models to simplify reality in
order to improve our understanding of the
world.
• Two of the most basic economic models are:
• The Circular Flow Diagram
• The Production Possibilities Frontier
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Our First Model: The Circular-Flow
Diagram
• The circular-flow diagram is a visual model of
the economy that shows how dollars and
resources flow through markets among
households and firms.
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© 2007 Thomson South-Western
Figure 1 The Circular Flow Model
MARKETS FOR
GOODS AND SERVICES
•Firms sell
•Households buy
Revenue
Spending
Goods and
services
received
Produced goods
and services
FIRMS
HOUSEHOLDS
Factors of
production
Labor, land,
and capital
MARKETS FOR
FACTORS OF PRODUCTION
Wages, rent,
and profit
•Households sell
•Firms buy
Income
= Flow of inputs
and outputs
= Flow of dollars
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Our Second Model: The Production
Possibilities Frontier
• The production possibilities frontier is a graph
that shows the combinations of output that the
economy can possibly produce given the
available factors of production (resources) and
the available production technology.
© 2007 Thomson South-Western
The Production Possibilities Frontier
Quantity of
Computers
Produced
If all resources were used, you can
The PPF shows you the
make 3,000 computers and 0 Cars.
maximum amount of resources
Or, you can make 1,000 cars and 0
you have
for production
computers
3,000
A
2,200
Production
Possibilities
Frontier
0
600
1,000
Quantity of
Cars Produced
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The Production Possibilities Frontier
Quantity of
Computers
Produced
A=
B=
C=
D=
E=
C
3,000
A
2,200
2,000
B
Production Efficiency
Production Efficiency
Not possible!
Underutilization
Efficiency &
specialization in
car production
D
1,000
E
0
300
600 700
1,000
Brain Busta!!!
Quantity of
Cars Produced
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Our Second Model: The Production
Possibilities Frontier
• Concepts illustrated by the production
possibilities frontier
• Allocation of resources
• Opportunity cost
• Economic growth
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PPF Questions…
Quantity of
Computers
Produced
1. What is the opportunity cost of moving
production from point A to point B?
2. What is the opportunity cost of moving
production from point D to point B?
3,000
A
2,200
2,000
B PPF to shift?
What can cause the
D
1,000
0
300
600 700
1,000
Quantity of
Cars Produced
© 2007 Thomson South-Western
A Shift in the Production Possibilities Frontier
Quantity of
Computers
Produced
Something changed that
What do you think would
caused there to be more
cause the PPF to shift
resources in computer
this particular way?
production.
4,000
3,000
2,300
2,200
0
G
A
600 650
of
1,000 CarsQuantity
Produced
© 2007 Thomson South-Western