The Three Key Questions for Economic Systems

Three Economic Questions Every society must answer three economic questions… 1.WHAT? 2.HOW? 3.FOR WHOM? How that society answers the questions determines which type of economic system that society employs

WHAT TO PRODUCE? WHAT goods and services will be produced with the available resources?

HOW TO PRODUCE? HOW will the available resources be combined to produce goods and services?

FOR WHOM TO PRODUCE? WHOM will be the consumer of the product or service?

Three Economic Systems Command Economies Traditional Economies Market Economies

COMMAND ECONOMIES Answer the key questions through a central authority made up of an individual or a number of individuals who make the decisions of what to make, how to make it, and for whom things should be made. –Communism –Socialism

TRADITIONAL ECONOMIES Answer the key questions by relying on past customs and practices

MARKET ECONOMIES Answer the key questions by a system of supply and demand. The ability of markets to coordinate economic activity is emphasized by Adam Smith in “The Wealth of Nations.” –This is what he referred to as the Invisible Hand

The Invisible Hand...every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

Invisible Hand What is Adam Smith basically saying with this passage? –If individuals are allowed to pursue their own self- interest, then everyone ends up better off. What do you think Adam Smith envisioned as the role of Government in the economy? –In a “Free” Market Economic System the Government would allow the invisible hand to regulate the economy and seldom intervene.

Economic Spectrum On a scale of 1 to 10 (1 being completely Command Economy & 10 being a Market Economy); where would you place the United States? 1 10 The United States probably would lie around 7 and 8 In the United States we have what is known as a MIXED ECONOMY…in fact pretty much every country is a mixed economy combining aspects of command and market economies.

Activity Need six volunteers… –Round 1: Part A: when I say go you can try and grab as many markers as possible…for every marker that you grab you will get a 100 theoretical dollars. Part B: when I say go you can try and grab as many markers as possible…for every marker that you grab you will get 200 theoretical dollars.

Activity –Round 2: Part A: when I say go you can try and grab as many markers as possible from your section…for every marker that you grab you will get 100 theoretical dollars Part B: when I say go you can try and grab as many markers as possible from your section…for every marker that you grab you will get 200 theoretical dollars.

DISCUSSION What do you think we just witnessed? Discuss how incentives were demonstrated in the activity? How does it apply to government and economic systems?