Chapter 2
Economic Systems
Economic Systems
•In this lesson, students will examine the four
economic systems.
•Students will be able to define the following
terms:
•An Economic System
•Traditional Economy
•Free Market Economy
•Centrally Planned Economy
•Mixed Economy
What goods and services will a country
produce?
An Economic System
• An economic system is a method used by a
society to produce and distribute goods and
services.
• There are three key questions addressed by
every economic system:
• What goods and services will be produced?
• How will these goods and services be produced?
• Who will consume these goods and services?
• What Should be produced? We live in a world of scarcity and
trade-offs. If more of one particular item is produced, then less of
something else will be produced.
• How Should It Be Produced? After deciding what to produce, an
economic system must then decide how those goods and services
will be produced. A decision must be made as to how the
combination of available inputs will get the job done for the least
cost.
• For Whom Should It Be Produced? After goods or services are
produced, the type of economic system under which people live
determines how the goods and services will be distributed among
its members. Most goods and services in the United States are
distributed to individuals and businesses through a price system.
Who will consume these goods?
That is a key economic question.
Nations, like people, answer the key
economic questions differently.
A Traditional Economy
• In a traditional economy, people live and work as their
ancestors lived and worked.
• In a traditional economy, we
• produce what our ancestors produced.
• produce it the way our ancestors did.
• distribute it the way our ancestors did.
It’s all about the ancestors.
Traditional economies do not
encourage change.
A Free Market Economy
• In a free market economy, people are free to buy and sell
whatever their money allows within the legal limits of the law.
• The government does not interfere in the business of business.
• The individual has economic freedom.
In a free market, individuals are free
to buy and sell.
A Centrally Planned Economy
• In a centrally planned economy, the
government makes all economic decisions.
• The government answers the three key
economic questions.
• Karl Marx advocated a centrally planned
economy.
Communists advocate centrally planned
economies.
A Mixed Economy
• Modern nations have mixed economies.
• A mixed economy combines elements of the other three
economic systems.
• However, it is important to remember that nations mix their
economic systems differently.
Just as every person mixes a milkshake
differently, so, too, do nations mix their
economies differently.
Questions for Reflection:
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Define an economic system.
What are the three key economic questions?
Describe life in a traditional economy.
Describe life in a free market economy.
How does a centrally planned economy differ from a free
market economy?
• Why do modern nations prefer mixed economies?
The Free Market
•In this lesson, students will identify characteristics
of the Free Market.
•Students will be able to define the following
terms:
•Adam Smith
•Laissez-faire
•Self-interest
•Competition
Adam Smith was the first economist.
In his book, The Wealth Nations (1776),
Adam Smith explained how free markets
functioned.
Markets are places where people can
exchange the things they have for the
things they want.
The Free Market
• In a free market economy, people are free to buy and sell
whatever they want within the legal limits of the law.
• Obviously, we do not live in a completely free market economy.
• There are some restrictions on what we can buy and sell.
In the United States today, there are some
products that we cannot legally buy. We
can buy a rifle but not this gun.
Laissez-faire
• Laissez-faire is the doctrine that states that the government
should not intervene in the marketplace.
• It means “let them do (as they please)”.
• In a free market, the government does not regulate the
economy.
Adam Smith believed that an Invisible Hand
existed or that the market would always fix
itself.
The Invisible Hand is the idea that the economy fixes itself.
If there is demand for a good that currently does not exist
in the market, some enterprising entrepreneur
will eventually produce it.
Adam Smith
• Adam Smith was the first person to explain how the free
market functioned.
• He did not invent the free market rather he explained how it
functioned.
• His book, The Wealth of Nations, is still considered a classic
today.
Competition and self-interest allow markets
to function effectively.
Competition and Self-Interest
• Competition is the struggle among producers for the dollars of
consumers.
• Self-interest is acting on behalf of one’s personal gain.
• Competition and self-interest make markets work.
Competition leads to lower prices and
better quality. When consumers have
choices, producers must offer
worthwhile products.
Every person has his or her best interest
in mind. This photograph is an example.
The tutor is interested in earning money
and the student is interested in learning.
Questions for Reflection:
• Who was Adam Smith?
• How does a free market economy differ from a traditional
economy?
• Define Laissez-faire.
• How does the market fix itself?
• How do competition and self-interest help the market function
efficiently?
• What is the Invisible Hand?
A Centrally Planned Economy
In this lesson, students will identify
characteristics of a centrally planned economy.
Students will be able to identify and/of define
the following terms:
Centrally Planned Economy
Communism
Problems of a Centrally Planned Economy
Karl Marx advocated a centrally planned
economy in his book, The Communist
Manifesto (1848).
In the early days of the Industrial Revolution,
workers were exploited or mistreated.
Children even worked in factories.
Sure, a few industrialists and capitalists
Became very wealthy but…
Most people worked long hours for
low wages in unsafe working conditions.
Karl Marx encouraged workers to unite
and violently overthrow the Capitalist
class in order to create a more just
society.
“Workers of the world unite;
you have nothing to lose but
your chains.”
Marxism
Marxism is frequently referred to as communism.
Characteristics of a Marxist Society:
• Dictatorship
• Government ownership of the Factors of Production
• Economic Equality
It sounds like paradise: A society where
there is no poverty, no want but…
Problems of a Centrally Planned Economy
Many problems exist in centrally planned economies.
The Problems of a Centrally Planned Economy:
• Workers lack incentive because all workers are rewarded
equally.
• Productivity and efficiency decline.
• Innovation is not rewarded.
• Individual freedoms are sacrificed.
Think about it!
Would you work hard if you were rewarded
The same as the lazy worker beside you?
Eventually, the Soviet Union collapsed and
the formerly Communist republics began
to transition to largely free market
economies.
Transition has been difficult for Russia.
A new economic perspective must be
created and previously Governmentowned factories must be privatized.
Questions for Reflection:
• How does a centrally planned economy differ from a free
market economy?
• Who was Karl Marx and what did he advocate?
• Describe a Communist society.
• What problems are created by centrally planned economies?
• Define transition.
Modern Economies
In this lesson, students will identify
characteristics of modern economies.
Students will be able to define and/or identify
the following concepts and terms:
Mixed Economy
Laissez-faire
Free Enterprise
Just as this apple is not perfect, economic
systems are not perfect. While a centrally
planned economy has many problems, a
free market economy is far from perfect.
A Mixed Economy
• A mixed economy combines elements of
different economic systems to meet the needs
of the society.
• While modern economies are mixed, every
mixed economy is slightly different from every
other mixed economy.
• Some nations lean more towards central
planning with some private ownership while
other nations are predominantly free market
with limited government intervention.
The Chinese communists seized power
in 1949. However, today, the Chinese
embrace elements of the free market.
The Chinese communists realized that
workers needed incentives or reasons
for increasing productivity.
The United States is a mostly free
market economy. However, the
government does intervene in the
market.
It is important to remember that many
abuses occurred in a totally free market.
Child labor is one example of this
abuse.
Laissez-faire
• Laissez-faire was the belief that the government should not
intervene in the market.
• It meant “let them do (as they please).”
• It allowed businesses to operate without any restrictions.
Without government intervention, warning
labels would not exist.
Heroin could be purchased in your
local supermarket.
Government intervention protects
our environment and our lives.
Free Enterprise
• The United States’ economic system is called the Free
Enterprise system.
• A Free Enterprise system is a mostly free market economy with
limited government intervention.
• The government does intervene in the economy when it is in
the public interest.
So, modern nations have mixed economies.
However, like milkshakes, mixed economies
are not mixed the same.
E. Napp
Questions for Reflection:
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Define a mixed economy.
What problems are created by central planned economies?
What problems are created by free market economies?
Define Laissez-faire.
What is the Free Enterprise system of the United States?
E. Napp