21. Six Characteristics of Market Systems Chapter Objectives1. Six Characteristics of Market Systems2. Three Characteristics of all Economic Systems3. Reasons for Three-way Trade4. Economic SystemsA. Traditional – “Custom rules”B. Command – “Government rules”C. Market – “Individuals rule”D. Mixed1.) Capitalism2.) Communism3.) Democratic Socialism
3Why Do We Have Economic Systems? Survival for any society depends on its ability to provide food, clothing, and shelter for its people.The Economic System is the organized way a society provides for the wants and needs of its people.
4Six Characteristics of Market Systems PRIVATEPROPERTYFREEDOM OFENTERPRISE& CHOICEROLE OFSELF-INTERESTCOMPETITION
5Characteristics of Market Systems FREEDOM OFENTERPRISE& CHOICEPRIVATEPROPERTYROLE OFSELF-INTERESTCOMPETITIONMARKETS& PRICESACTIVE, BUTLIMITED,GOVERNMENT
61. Private Property – the right of individuals to exercise control over things owned. Freedom tonegotiate binding legal contracts.Contracts are legally binding in oral or written form.[A verbal agreement is binding only if it involves a small sum of moneyover a short period of time and does not involve real estate purchases.]2. Freedom of Enterprise (business) & ChoiceCan move within the economy to any job, tobuy or sell property, or start a business.The consumer is “sovereign” (king) in the economy. Hisdollars vote as it is he who decides what gets produced.The U.S. has over 100,000 business failures each year.K-Mart?3. Role of Self-Interest–each producer or consumertries to do what is best for themselves. Self interest-profit motive is the main force driving the economy.Producers aim for maximum profits.Consumers seek the lowest prices & highest quality.
7A monopoly’s attitude is: “self-interest” are like Pure Capitalism (No G) and the Circular Flow[Capitalism – “private ownership of capital”]4. Competition – economic rivalry of a large number ofbuyers & sellers. [central mechanism of market economy]Monopolies become fat & unresponsive to consumers(higher prices & fewer choices). Competition preventsone seller from controlling the market. Monopolies are“price makers”. It is better to have “price takers”who are at the “mercy of the market.”A monopoly’s attitude is:“We don’t care.We don’t have to.We’re a monopoly!”And – an appendageto be named later,like a -Monopolies can chargean arm and a leg.“Competition” and“self-interest” are likean “invisible hand”.So, the “invisible hand” refers to the way a marketeconomy manages to harness the power of self-interestfor the good of society.
8We have “Market Inventors” 5. Markets & prices. Markets bring the buyers and sellers into contact.Prices send signals High prices send signals to increaseproduction and for other producers to enter the market.Low prices send signals to decrease productionand for producers to exit the market.We have “Market Inventors”like AL GORE!!!6. Limited Government Intervention in the economy.The role of government was one of “laissez faire.” [“hands off”]In the words of Adam Smith, the government should not interfere withthe operation of the economy except serve as an arbitrator in settlingdisputes.The government’s role:(according to Smith)a. provide defense,b. administer justice, andc. maintain certain public institutions.The government controls about 1/3 of economic activity.Arbitrator[settling disputes]
9The Role of the Government ProtectorThe government makes and enforces laws against:False advertising, unclean food, pollution & unsafe productsThey enforce laws against discrimination in the work place.The government enforces contracts.Provider and ConsumerProvides products & services that businesses don’t provide,like: public schools, roads, an army, and welfare.The government is also a consumer because it buys things from businesses, like: fighter jets, aircraft carriers, submarines and tanks.RegulatorThe government regulates or makes rules for businesses to follow. For example, the government decides which frequency radio stations can broadcast on. The government also makes rules for running nuclear power plants & so on…
10Use of Money Specialization and Efficiency 3 Characteristics of all Economic SystemsReliance onTechnologyandCapital GoodsUse of MoneySpecializationandEfficiency
111. Reliance on Technology Three Characteristics of all Economic Systems1. Reliance on Technologyand Capital GoodsAssembly line [roundabout production]results in more efficient productionand more output.Farmers are more efficient using capital goods[plows & tractors] instead of their hands.RoundaboutProduction
121. Reliance on Technology 2. Specialization and Efficiency Three Characteristics of all Economic Systems1. Reliance on Technologyand Capital Goods2. Specialization and EfficiencyMakes Use of Differences in AbilityFosters Learning by DoingSaves Time[A slow person can fishand a fast person can be a hunter]
13[when bilateral trade is not beneficial] Multilateral Trade[when bilateral trade is not beneficial]Texas RangersThree-wayExchange
14NS 52-54 Crusoe Saturday Friday Has surplus fishWants coconutsSaturdayHas surplus bananasWants fishFridayHas surplus coconutsWants bananas52. Crusoe would get coconuts from (Friday/Saturday).53. There (is/is no) coincidence of wants between any 2 states.54. Money would flow (clockwise/counterclockwise).55. The “coincidence of wants” problem means each transactor(must/must not) have a product which the other wants.
151. Reliance on Technology 2. Specialization and Efficiency Three Characteristics of all Economic Systems1. Reliance on Technologyand Capital Goods2. Specialization and EfficiencyDivision of Labor
16Reliance on Technology 2. Specialization and Efficiency Three Characteristics of all Economic SystemsReliance on Technologyand Capital Goods2. Specialization and EfficiencyGeographic SpecializationTexasFloridaNebraska
171. Reliance on Technology Three Characteristics of all Economic Systems1. Reliance on Technologyand Capital Goods2. Specialization and Efficiency3. Use of MoneyAs a Medium of Exchange
18Reliance on Technology 2. Specialization and Efficiency Three Characteristics of all Economic SystemsReliance on Technologyand Capital Goods2. Specialization and Efficiency3. Use of MoneyMoney Eliminates Barter System Difficulties
19Index of Economic Freedom [Ranking of 157 countries for 2010] 1. Hong Kong3. Ireland5. United StatesFREE20. Belgium31. Spain48. FranceMOSTLY FREE101. Brazil126. China146. RussiaMOSTLY UNFREE148. Venezuela156. Cuba179. North KoreaREPRESSED
20NS 50-51 50. The following is unique to capitalist ideology: (use of money/ specialization/private ownership of property).51. “Roundabout production” [assembly line] leads to:(use of fewer capital goods/greater production).
21Basic Economic Choices Type of Economic System What to produceHow to produceWho receivesScarcity ImposesWhat, how, & for whom.Answers Determine TheType of Economic SystemMarketTraditionalCommand
22The Market System At Work The Three Basic Questions...What, how, & for whom1. What will be produced?
23The Market System At Work The Three Basic Questions...1. What will be produced?2. How will the goods be produced?
24The Market System At Work The Three Basic Questions...1. What will be produced?2. How will the goods be produced?3. Who will get the goods & services?
25Competition and the Invisible Hand Smith is saying that participants in the economy are motivated byself-interest & that the “invisible hand” of the marketplace guidesthis self-interest into promoting general economic well-being.The Case for the Market SystemAdam Smith said the “invisible hand” determines whatgets produced, how, & for whom. It is the invisible handthat moves us along the PPC. The invisible hand is nowcalled the market mechanism. Its essential feature isthe price signal.
26Answers to the above determine: ScarcityUnlimitedWantsLimitedResourcesChoicesWHAT G/Sto produce?WHO will receivethe G/S produced?HOW will theG/S be produced?Most needy or most money3 BASICECONOMICQUESTIONSAnswers to the above determine:ECONOMIC SYSTEMS[Eskimo/pygmy]TRADITIONALCOMMANDFREE MARKET
27The 6 Miracles of Socialism Economic SystemsA. Traditional – “Custom rules”B. Command – “Government rules”C. Market – “Individuals rule”D. Mixed1.) Capitalism – modified free enterprise2.) Communism – command w. some market3.) Democratic Socialism – socialist democraciesThe 6 Miracles of Socialism1. There’s no unemployment, but nobody actually works.2. No one works, but everyone gets paid.3. Everyone gets paid, but there’s nothing to buy with the money.4. No one can buy anything, but everyone owns everything.5. Everyone owns everything, but no one is satisfied.6. No one is satisfied, but 99% of the people vote for the system.
28– the way society produces products Economic SystemsI’m amused by this technology butwe are not going to incorporate thisinto our way of living.TraditionalPure CommandPure MarketMixeda. Capitalismb. Democratic Socialismc. Authoritarian Socialism [Communism]The way the 3 basic questions are answereddetermines an economic system.Traditional-[where “CUSTOM RULES”]A. What, how, and for whom are answered by traditionB. Change is resisted, no technology [clashes with tradition]C. Heredity and caste system limit the economic role of individuals.D. The Pygmies of the Ituri Forest, in the Congo, are an example.E. Men hunt & women/children gather/prepare food.F. Wear loincloths from bark of fig trees [“PYGLER” or “PYBUGLE Boy”]G. Eat mushrooms, berries, roasted grasshoppers, monkeys, & plantainH. Eat bone marrow & everything else in an elephant.I. Used to be “PYGACHE” loincloths, big Pygmies, had to wear “LARDACHE.”
29Strengths Weaknesses 1. Traditional Economy Economic activity is based on ritual, habit and custom.StrengthsEveryone knows their role.Little uncertainty over what to produce or how to produce.The question of For Whom to produce is answered by custom.Life is generally stable, predictable, and continuous.WeaknessesTends to discourage new ideas.Lack of progress leads to lower standard of living.
30Strengths Weaknesses 2. Command Economy Government “rules”. Economic decisions are made at the top and the people are expected to go along with choices their leaders make.StrengthsChange direction drastically in a relatively short time (The USSR went from an agrarian to industrial nation in a very short time).WeaknessesFidel CastroNot designed to meet the wants and needs of individuals.Lack of incentives to work hard leads to unexpected results.Large bureaucracy for economic planning.Not flexible in dealing with minor day to day problems.People with new or unique ideas are stifled.Karl Marx
313. Market Economy – where “individuals rule” Individuals & firms control all resources.The government has no say. WHAT, HOW and FOR WHOM are decided by individuals.Adam SmithA Mixed EconomyA mixed economy is one that uses both market signals and government directives to allocate goods & resources.Most economies use a combination of market signals and government directives to select economic outcomes.
32WEALTH OF NATIONS – 1776 [explained the free market concept] Adam SmithWEALTH OF NATIONS – [explained the free market concept]The “INVISIBLE HAND” – when individual consumers/producers compete to achieve their own private self-interest.The “role of government” [“LAISSEZ-FAIRE” – “HANDS OFF”]is limited to national defense, public education, maintaining theinfrastructure, and enforcing contracts. Smith said the marketsystem was best because it encouraged specialization, resulting inincreased output & more economic growth.Government was like an “INVISIBLE FOOT” – government actionto benefit particular groups. Keynes will say the G can act as a pressuregauge, letting off excess steam or building it up as needed. [active-not all inclusive role]No “G”In loving memoryof mercantilismMy name is mercantilism.So mercantilism diedas economic theory.Smith’s book was an attack on mercantilism.Wealth doesn’t come from an accumulation of gold and silver butfrom more productive people. A nation is wealthier if its citizensAre more productive. It is the ability of people to produce productsand trade in free markets that creates a nation’s wealth.Mercantilism
33Self Interest [Profit Motive] & the “Invisible Hand” Smith said that we constantly try to make ourselves better off. It is self interestthat makes us work hard, take risks, & in the end benefit others thru our activities.If people want to serve their own self interest, they had to serve others first.It is not from the benevolence of the butcher, the brewer, or the baker, thatwe expect our dinner, but from their regard to our own interest.In other words, the butcher, brewer, and baker do not give us our dinnerbecause they love us or because they want to assist us. They give us our dinnerbecause they cannot get what they want from us until they first give us what wewant. Smith said we are led by an “invisible hand” to do good for others. In themost famous passage in The Wealth of Nations, he says:Every individual…neither intends to promote the public interest, nor knowshow much he is promoting it…he intends only his own gain, and he is in this,as in many other cases, led by an “invisible hand” to promote an endwhich was no part of his intention.Of course, Karl Marx saw self interest as hurting others. Hebelieved capitalists exploited the workers by paying them farless what they were worth.
34Specialization Self Interest Laissez Faire Economics(No government intervention)The Wealth of Nations1776Self InterestAdam SmithScotlandThe Invisible HandFather of Economics [Adam Smith]
35Strengths 3. Market Economy People and firms act in their own best interest to answer economic questions.Markets allow buyers and sellers to come together in order to exchange goods and services.StrengthsMarkets can adjust over time.Freedom exists for everyone involved.Relatively small degree of governmental influence.Decision making is decentralized.Variety of goods and services are produced.High degree of consumer satisfaction.Adam Smith“Invisible” hand
36Weaknesses of a Market Economy The primary weakness is deciding for whom to produce.The young, sick and old would have difficulty in a pure market environment.Markets sometimes fail.Competition (monopolies may develop)Resource mobility (resources are sometimes hindered from moving about)Availability of information (producers often have more information than do consumers, which gives them an advantage)
37Adam Smith’s famous Pin Factory Example One man could do maybe 10 pins per day [1 man = 10 pins]Now if there is specialization1 man draws the wire out1 man straightens the wire1 man cuts the wire1 man sharpens the point1 man flattens the headThere are 18 distinct operations- some perform 2 or 3 operations10 people do 48,000 pins per day1 man = 4,800 pins per dayThree circumstances come from this specialization.1. Increased dexterity (learning by doing)2. Saving time (lose time when you moveto different operations)3. Invention of machines (fosters inventiveness)
38Economic Freedom You are free to: Choose your occupation Choose where and when you workWork for yourself or someone elseLeave your job and to move to another jobBusinesses are free to:Choose which workers they wantChoose where and how they produce