Adam Smith’s Market Economy AP Macroeconomics Adam Smith’s Market Economy Economic Logic of a Market System

All Economic Systems Allocate Resources Market Command Traditional Every Economic System has to answer 3 Questions: 1) What to Produce? 2) For whom to Produce? 3) How to Produce it? (or when to produce)

Which Economic System? WHAT ECONOMIC SYSTEM? Society will choose an economic system based on goals: Economic Goals & Social Goals Growth Employment Efficiency Stability Justice Equality Environment Freedom

Adam Smith (1723-90) Founder of Free Market Economics Argued: Free markets best promote the social welfare Government should generally not interfere! “The Wealth of Nations” Published in 1776

"It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” “We address ourselves, not to their humanity but of their advantages." Adam Smith Rule #1: Self-interest creates an incentive to work hard Rule #2: Competition keeps us honest End Result: An “invisible hand” will guide the economy to the best market outcome for society.

Reading: The Free Market at Work High Prices Scarce Resources

Review Wealth Creation & Free Market Please buy my Vulture Scarce Resources

Adam Smith & The Invisible Hand People follow their own self-interest Threat of competition keeps people honest Markets naturally self-regulate Invisible Hand Government should not Interfere! End result: low prices & many choices/options

HOW WHAT FOR WHOM MARKET SYSTEM Growth & Efficiency Supply & Demand Market Economic System Summary Production HOW WHAT FOR WHOM Growth & Efficiency Supply & Demand Price MARKET SYSTEM Benefits Costs Tremendous consumer choice ↑ career opportunity Unlimited Upside ($) Strong incentive to innovate Low prices & high quality Creates wealth Generally self-regulates High Stress ↑ incentive to cheat ↑ inequality (rich-poor gap) ↑ environmental impact

Command Econ Systems Soviet Union “adopts” command economic system Karl Marx 1848 Soviet Union “adopts” command economic system i.e. communism General Philosophy: Government controlled economy (centrally planned) stressed equality & the common good (collective society) Economic Incentive to innovate, work hard ? Work hard for the “collective” good of society Shortage of a good => what happens?

Self-Regulation vs. Central Planning Market Economy Command Economy Shortage of A Good? Invisible Hand

Economic Systems Trade-offs Efficiency vs. Equity Free markets systems focus on efficiency Command systems focus on equity Efficiency means society gets the most from its scarce resources Equity means the benefits of scarce resources are distributed fairly in society (not necessarily equally!) 9

HOW WHAT FOR WHOM MARKET COMMAND TRADITIONAL Growth & Efficiency 3 Questions for each Economic System HOW WHAT FOR WHOM “to produce” “to produce” “to produce” Economic System Growth & Efficiency Supply & Demand Price MARKET Equality Gov’t or Central Planner Employment COMMAND Need [Tradition] Need/ Necessity Stability TRADITIONAL

Crash Course Economics Video: Economic Systems (10 minutes) Market Systems vs. Command Systems https://www.youtube.com/watch?v=B43YEW2FvDs

Traditional Economic System Designed to preserve culture of society Change occurs very slowly Gov’t uses strict laws to enforce behavior CHINA

Bhutan Video: Traditional Economy Gross National Happiness https://www.youtube.com/watch?v=sAtMqwh21Eo 6 minutes

Bhutan June 2011 Typical Village Largest City Music Video

Summary Market systems stress competition Work “individually” in your own “self interest” Invisible hand regulates economy Command systems stress equality Work “collectively” for the common good Government centrally plans economy Traditional systems stress preservation of culture Government maintains culture of society Stability more important than efficiency

Bhutan June 2011 Typical Village