Types of Economic
Systems
THREE KEY ECONOMIC QUESTONS
All societies must answer three key
economic questions:
1. What goods and services will we
produce?
2. How will we produce them?
3. Who will consume them, have
access to them, benefit from them?
Economic Goals and Societal Values
Different societies answer the three key
economic questions based on the
importance they attach to such economic
goals as:
1.
Economic Efficiency – making the most of
available resources
2.
Economic Freedom – freedom from
governmental intervention in the
production and distribution of goods and
services
3. Economic Security and Predictability –
assurance that goods and services
will be available, payments will be
made on time, and a “safety net” will
protect people in times of economic
crisis.
4. Economic Equity – fair distribution of
wealth
5. Economic Growth and Innovation –
innovation leads to economic growth;
economic growth leads to a higher
standard of living
6. Other Goals – societies pursue other
goals, such as environmental
protection
All six of these should be understood to
be advantages of the U.S. free
enterprise system!
TYPES OF ECONOMIC SYSTEMS
1. TRADITIONAL
2. COMMAND
3. MARKET
4. MIXED
TRADITIONAL ECONOMY
THINGS ARE DONE BASED ON
TRADITION, THE WAY THINGS HAVE
ALWAYS BEEN DONE
CHILDREN OFTEN FOLLOW IN THE
ROLES/JOBS OF THEIR PARENTS
LITTLE ROOM FOR INNOVATION
COMMAND ECONOMY
In a centrally-planned (or command)
economy, the government owns the land and
the capital. It really controls labor too
because it controls where people work and
how much they are paid.
The government makes the decisions (called
central planning) about what to produce, how
to produce it, and who will benefit from it.
Two Common Types of
Command Economies
(1) Socialism-belief that democratic
means should be used to evenly
distribute wealth throughout a society
Socialists believe that real
equality can only exist when
political equality is coupled
with economic equality.
Socialists believe
economic equality
is really only possible if the
government controls the
centers of economic power,
not so much individuals.
Socialist nations
may be democratic,
but they require a high degree
of government
controls of the economy
(central planning).
The second kind of command economy…
(2) Communism-a centrally planned
economy with all economic and
political power in the hands of the
central government
Unlike socialists,
communists believe that
a socialist society, where
real equality exists,
can only come about
through violent revolution.
While socialist economies may still
allow for democracy, communist
governments are authoritarian –
the government exacts strict
obedience from the citizens and
does not permit individual
freedom of thought or action.
The former Soviet Union (1917-1991)
provides us with a good case study
of how a centrally-planned
economy works – and doesn’t
work.
(On your own, be sure to study
carefully textbook pages 36-38)
MARKET ECONOMY
In a market economy, the key
economic questions are answered
by private citizens and businesses
acting according to their own selfinterest, without government
interference.
Market economies work according to
Adam Smith’s “invisible hand” theory
found in his classic book The Wealth of
Nations (1776).
What is the “invisible hand” theory?
The idea that economic choices based on
self-interest result in economic growth
that benefits everyone.
A market economy is based on
consumer sovereignty-the individual
consumer, acting in his or her own selfinterest, decides what gets produced,
how much is produced, and, ultimately,
who will receive the benefits of the
production of the products.
MIXED ECONOMY
A MIXED ECONOMY COMBINES ELEMENTS
OF TRADITIONAL, COMMAND, AND MARKET
MODELS
MOST ECONOMIES IN THE WORLD TODAY
ARE THIS (INCLUDING OURS).
VERY FEW - IF ANY - PURE ECONOMIC
SYSTEMS TODAY (MOST ARE MIXED,
LEANING TOWARD ONE OF THE THREE
MAJOR TYPES).
FOR EXAMPLE, IN THE U.S., WE HAVE
A MIXED ECONOMY THAT LEANS
TOWARD A MARKET ECONOMY.
FRANCE, ON THE OTHER HAND, WITH
AN ECONOMY MORE SOCIALISTIC
THAN OURS, HAS A MIXED ECONOMY
THAT LEANS TOWARD A COMMAND
SYSTEM.
It remains to be seen if the current
economic crisis we are in will result in
a change in the overall direction of our
economy, from one that continues to
lean toward market economics to one
that leans toward command
economics.
CAPITALISM / FREE ENTERPRISE
Individuals own the means of production,
answer the three great economic questions
Govt. has a limited role: taxation, provides
services, regulates business
Constitutional right to private property
Right of voluntary exchange
Recognition of contracts
THE SELF-REGULATING NATURE
OF THE MARKETPLACE
How is it that firms and households
cooperate to give each other what they want
– factor resources, in the case of firms,
products in the case of households?
Anyone who has ever applied for a job
understands that our society is strongly
competitive.
According to Adam Smith, in The Wealth of
Nations, it is, in fact competition and our own
self-interest that keep the marketplace
functioning.
SELF-INTEREST
Smith observed that an economy is made up
of countless individual transactions.
In each transaction, the buyer and the seller
act out of their own self-interest, in other
words, each seeks his own personal gain.
SELF-INTEREST, therefore, is the motivating
force in the free market.
COMPETITION
Consumers (households), pursuing their own
self-interest, have the incentive to look for
lower prices.
An incentive is the hope of reward or the fear
of punishment that encourages a person to
behave in a certain way.
Adam Smith observed that people respond
predictably to both positive and negative
incentives.
Modern psychologists agree. They tell us
that we are all motivated, from moment to
moment, by the principle of pleasure seeking
– pain avoidance.
As for consumers (buyers, customers,
households), we can predict that they will
respond favorably to the positive incentive of
lower prices.
Why? Because spending less money on a
good lowers the opportunity cost of the
purchase.
As for firms (businesses,
manufacturers, etc.), there are two
great incentives:
(1) To make greater profits
by increasing sales of
their product
(2) To make greater profits
by selling their product
at the highest possible
price.
Economists call the struggle among
producers for the dollars of consumers
competition.
While self-interest is the motivating
force behind the free market,
competition is the regulating force.
THE INVISIBLE HAND
Self-interest (personal gain) inspires
consumers to purchase certain goods and
services and firms to produce them.
Competition among producers (suppliers of
goods and services) causes more production
and moderates firms’ quests for higher
prices.
The result? Consumers get the products they
want at prices that closely reflect the cost of
producing them.
All this happen without any central plan or
direction.
Adam Smith called this “the invisible hand of
the marketplace.”
NOTE: NO PURE FREE MARKET
SYSTEMS EXIST ON A MEANINGFUL
SCALE (HONG KONG AND
SINGAPORE COME CLOSEST).
NOTE ALSO: THE SAME FEATURES
THAT MAKE THE FREE MARKET
ATTRACTIVE ARE ALSO ITS MAIN
WEAKNESSES – THE FACT IS, IN A
SYSTEM BASED ON ECONOMIC
FREEDOM, ECONOMIC EQUITY AND
SECURITY ARE HARD TO COME BY.
IN TODAY’S WORLD, THE FREE MARKET
SYSTEM HAS BEEN MODIFIED BY
VARIOUS COUNTRIES TO BETTER
MEET ALL OF THEIR ECONOMIC
GOALS.
PRESIDENT GEORGE W. BUSH, IN HIS
FINAL PRESS CONFERENCE ON
MONDAY, JANUARY 12, 2009,
ADMITTED THAT HE’D HAD TO PUT
ASIDE MANY OF HIS OWN PERSONAL
FREE-MARKET BELIEFS TO DEAL
WITH THE ECONOMIC CRISIS THAT
BEGAN IN SEPTEMBER, 2008.
In the United States, ours is a mixed economy
based on the principles of free enterprise (or
capitalism):
Laissez Faire
The idea that government generally should not
intervene in the marketplace
Private Property
Property that is owned by individuals or
companies, not by the government or the
people as a whole
Free Enterprise
Private or corporate ownership of capital
goods;
Investments determined by private
decisions, not by government controls