Three Basic Questions What to produce (includes how much) How should we produce goods and services (ie. capital intensive or labor intensive)? For whom are we producing (distribution or wealth)?

Two (or three) Economic System Models How a society answers the basic economic questions determines what kind of system they are. Individuals answer the basic economic question in a free market. Government answers the basic economic questions in a command system.

Traditional Economic System The basic economic questions are answered based on custom and practice. The Amish are an example of this kind of system.

Mixed Economic System No nation has a pure market or a pure command economic system. All economies are mixed, meaning they have elements of both market and command systems. North Korea United States Command Market

Basic Economic Questions What to produce? How to produce? For whom are we producing? Big Idea – **The economic system of any country is based on how these three questions are answered!

The Basics of a Market Economy

List of Characteristics Voluntary Exchange Private Property Price System Profit Incentive Competition Financial Institutions Limited Government

Voluntary Exchange Trading goods and services with other people because both parties expect to benefit from the trade. Voluntary trade creates wealth.

Private Property Involves the right to exclusive use, legal protection against invaders and the right to transfer property to others. Property rights are defined, enforced and limited through the process of government.

Price System Price is the amount of money that people pay when they buy a good or service; the amount they receive when they sell a good or service. Prices in a free market are set by the forces of supply and demand. The price system provides important information to producers and consumers which encourages the efficient production and allocation of goods and services consumers demand.

Profit Incentive Profit is the differences between a business’s total revenues and its total costs. The profit incentive is the desire that persuades entrepreneurs to establish new businesses or expand existing ones, improve products, and cut costs of production. In a market economy, the profit incentive spurs on efficiency, growth, and economic progress.

Competition Attempts by two or more individuals or organizations to acquire the same goods, services, or productive and financial resources. Consumers compete with other consumers for goods and services. Producers compete with other producers for sales to consumers.

Financial Institutions Banks, credit unions, pension funds, insurance companies, mutual fund companies, and other organizations that bring together savers and borrowers and buyers and sellers of stocks and bonds. Play an important role in fostering economic growth and employment of resources in a market economy.

Limited Role of Government Provide a legal system to enforce contracts and private property rights. Provide public goods that individuals and businesses would not provide. Correct Market Failure Maintain Competition Redistribute Income Stabilize the Economy by reducing unemployment and inflation, and promoting economic growth.