1. The Market system
Lesson 3

2. Economic Systems Basic questions Economic systems Planned economy
Advantages and disadvantages
Market economy
Mixed economy

3. Basic Economic Questions
Any economic system must answer the three basic questions (how do we allocate our resources?)
1. What is produced?
What goods are services are produced?
2. How are those goods produced?
What production methods are used?
3. For whom?
Who gets which goods?

4. Economic Systems
Each system answers the three basic questions differently.
A market economy uses the price mechanism to allocate resources
A planned economy uses the planning mechanism to allocate resources

5. Countries classified by economic system
Market Economy
Command Economy
Mixed Economy

6. Economic Systems
Some standards used to distinguish among economic systems are:
Who owns the resources?
What decision-making process is used to allocate resources and products?
What types of incentives guide economic decision makers?

7. Countries classified by economic system
Economic system classified by the right mix of ownership and control of the economy
Ownership means those who own the resources engaged in economic activity---the public sector, the private sector, or both.
Control of economic activity refers to the fact that resources may be allocated and controlled by the public or the private sector.

8. Economic system Market economy
One in which individuals and private firms make the major decisions about production and consumption.
The resources are primarily owned and controlled by the private sector, not the public sector.
Command economy (centrally planned economy)
One in which the government makes all important decisions about production and distribution.
The government owns and controls all resources.

9. Economic system Mixed economy
Different degrees of ownership and control best describe most countries.
Most market economies have some degree of government ownership and control, whereas most command economies are moving toward a market economy and away from command concepts.

10. Summary
The three fundamental economic questions that all societies have to consider are what to produce, how to produce it and who receives what is produced
Economic systems can be classified as planned, market, and mixed
In a planned economy the government owns the factors of production and makes the key economic decisions
In a market economy there is private ownership of land and capital, consumers decide what is produced and resources are allocated through the price mechanism

11. Economic Systems A planned economy is also called Command economy
Command and control economy
Centrally planned economy
Collectivist economy
Communism
In a planned economy the government decides what to produce, how to produce it, and who gets to consume it

12. Economic Systems Planned economy Who owns the resources? The state
What decision-making process is used to allocate resources and products?
The state makes all decisions on production and consumption using central planning
What types of incentives guide economic decision makers?
Central planners are supposed make decisions that benefit society
Workers/firms have bad incentives

13. Economic Systems
To coordinate all activities in the economy, the government uses a central planning system
Its function was to identify what goods and services were needed by the people, how these goods and services would be produced and how the state output would be distributed
Prices are not used to determine resource allocation

14. Economic Systems What? How?
The central planner has to decide which goods to produce and the quantities of each good to produce, based on limited information about individual needs and wants.
How?
The government decides what it thinks are the best production methods, technologies, etc.

15. Economic Systems For Whom?
In return for the labour expended in producing this output, a wage was given
If there was anything in the stores, one could buy it.
In reality, most people had to use the black market to get goods, otherwise they would go without
When stores did have products, they were not good ones; there was little choice
Consumer often experience long queues for consumer goods.

16. Advantages of the planned economy
Wasteful competition is avoided
Deal with the externalities
Equal distribution of income and wealth
Effectively control inflation

17. Disadvantages of the planned economy
Misjudge the preferences of the consume
Consumers get low priority and little freedom of choice
Reduced incentive to work harder
Characterized by poverty and inefficiency partly because of bad incentives
Lack of competition between companies
Inefficient resource distribution – surplus and shortage

18. Economic Systems Planned Economies Examples
Closely associated with communist regimes in Russia and Eastern Europe that arose from 1917 onwards, finally collapsing in the late 1980s and early 1990s, and China, which has been going through a gradual transition
Planned economies still exist in some parts of the world, most notably in Cuba, North Korea, and some states in Africa

19. Economic Systems
In a market economy individual buyers and sellers, as a group, decide what to produce, how to produce it, and who consumes it.
The state does not play a role in the allocation of resources

20. Economic Systems
Adam Smith, one of the Founding Fathers of economics famously wrote of the “invisible hand of the price mechanism”.
He described how the invisible or hidden hand of the market operated in a competitive market through the pursuit of self-interest to allocate resources in society’s best interest.
This remains the central view of all free-market economists, i.e. those who believe in the virtues of a free-market economy with minimal government intervention.

21. Economic Systems
Invisible hand – the idea that self-interest and competition promote economic efficiency without any need for action by government.
People working in their own interest creates efficiency and prosperity.
To earn money, you must provide a good or service that someone wants to buy.
Competition for buyers motivates producers to improve quality and decrease cost.

22. Economic Systems Market economy Who owns the resources?
Private individuals
What decision-making process is used to allocate resources and products?
The price mechanism (supply and demand) in free, competitive markets
What types of incentives guide economic decision makers?
Profit incentives: any income derived from selling resources goes exclusively to each resource owner

23. Economic Systems
In a market economy what is produced is determined by consumers
This is because producers want to sell their products. They can only sell their products if consumers want to buy them. Therefore, producers must produce what consumers want to buy.
This is the idea of consumer sovereignty: consumers decide what is produced.

24. Economic Systems
In a market economy how to produce is determined by firms
To earn money, you must provide a good or service that someone wants to buy.
Firms a profit incentive. Competition for buyers motivates producers to improve quality and decrease cost. Thus, firms have incentive to produce as efficiently as possible, output can be maximised and waste is minimised
Firms have incentive to innovate.

25. Economic Systems
In a market economy who gets to consume ‘it’ is determined by income and wealth
This point is the most criticised of market economies.
Income is determined by ability – if you have none, you have no income
Wealth can be concentrated in the hands of a few people
Those with no income or wealth live in poverty

26. Economic Systems
The market system relies on a number of factors to ensure that it works efficiently.
The profit motive - the incentive for a reward for enterprise
Good levels of information being available to both producers and consumers
Price accurately reflecting the costs and benefits of consumption and production
The ease with which resources can move to different uses

27. Economic Systems Advantages of free markets More efficiency
Resources are allocated automatically.
Competition pushes businesses to be efficient: keeping costs down and production high.
Incentives are correct for firms and workers (profit motive for high quality and low cost)
The price mechanism transmits information to reallocate resources cheaply and quickly
Faster response to changes in consumer wants and real cost of resources

28. Economic Systems
The price system encourages producers and consumers to conserve scarce resources
Higher level of wealth than planned economy
Economic freedom (choose what you buy, what job to do, where you live, etc.)
The market gives producers an incentive to produce goods that consumers want
The market provides an incentive to acquire useful skills

29. Economic Systems Disadvantages of free markets Market failure
Lack of information
Buying too much of harmful products and not enough of beneficial products
Business may simply satisfy the wants they have created through advertising
Difficulty enforcing property rights
Some people have few resources to sell

30. Economic Systems
Monopolistic industries may restrict output and drive up prices
Markets just do not work in some areas (public goods, such as national defense)
Prices may give false or inadequate signals to producers and consumers (externalities, like pollution)
Market economies tend to produce a skewed distribution of income (large gap between the rich and the poor)

31. Economic Systems
A mixed economy has characteristics of both planned and market economies. Both the government and private citizens make decisions on allocating resources
The purpose of a mixed economy is to find a balance between the advantages and disadvantages of a market economy and a planned economy
One can think of this as a balance between efficiency and ‘equity’

32. Economic Systems Mixed economy Who owns the resources?
Individuals and the state
What decision-making process is used to allocate resources and products?
The price mechanism (supply and demand) and the government
What types of incentives guide economic decision makers?
Profit incentives, ‘equity’ incentives, and some bad incentives

33. Economic Systems
Sometimes we much choose between what is fair (equity) and what is efficient, and it can be difficult to have both. Why?

34. Economic Systems There are no pure market economies
There are few if any pure command economies
Most, if not all, economies are mixed economies

35. Economic Systems
The U.S. is considered a mixed economy. Some examples of this include:
People can own their own businesses, but political leaders make policies concerning these.
The government controls the mail system.
The government controls most of the road networks.
Waste collection and treatment are usually provided as a service by the local government.

36. Economic Systems
All American airports are government operated but all American airlines are private.
The government has created a minimum wage law.
The government provides social welfare payments to some citizens.
The majority of pre-college education is government-provided and a large part of tertiary education is run by state governments.
Some health care is provided by the government