Chapter 2 Economic Systems

Economic Systems In this lesson, students will examine the four economic systems. Students will be able to define the following terms: An Economic System Traditional Economy Free Market Economy Centrally Planned Economy Mixed Economy

What goods and services will a country produce?

An Economic System An economic system is a method used by a society to produce and distribute goods and services. There are three key questions addressed by every economic system: What goods and services will be produced? How will these goods and services be produced? Who will consume these goods and services?

What Should be produced. We live in a world of scarcity and trade-offs What Should be produced? We live in a world of scarcity and trade-offs. If more of one particular item is produced, then less of something else will be produced. How Should It Be Produced? After deciding what to produce, an economic system must then decide how those goods and services will be produced. A decision must be made as to how the combination of available inputs will get the job done for the least cost. For Whom Should It Be Produced? After goods or services are produced, the type of economic system under which people live determines how the goods and services will be distributed among its members. Most goods and services in the United States are distributed to individuals and businesses through a price system.

Who will consume these goods? That is a key economic question.

Nations, like people, answer the key economic questions differently.

A Traditional Economy In a traditional economy, people live and work as their ancestors lived and worked. In a traditional economy, we produce what our ancestors produced. produce it the way our ancestors did. distribute it the way our ancestors did.

It’s all about the ancestors. Traditional economies do not encourage change.

A Free Market Economy In a free market economy, people are free to buy and sell whatever their money allows within the legal limits of the law. The government does not interfere in the business of business. The individual has economic freedom.

In a free market, individuals are free to buy and sell.

A Centrally Planned Economy In a centrally planned economy, the government makes all economic decisions. The government answers the three key economic questions. Karl Marx advocated a centrally planned economy.

Communists advocate centrally planned economies.

A Mixed Economy Modern nations have mixed economies. A mixed economy combines elements of the other three economic systems. However, it is important to remember that nations mix their economic systems differently.

Just as every person mixes a milkshake differently, so, too, do nations mix their economies differently.

Questions for Reflection: Define an economic system. What are the three key economic questions? Describe life in a traditional economy. Describe life in a free market economy. How does a centrally planned economy differ from a free market economy? Why do modern nations prefer mixed economies?

Students will be able to define the following terms: The Free Market In this lesson, students will identify characteristics of the Free Market. Students will be able to define the following terms: Adam Smith Laissez-faire Self-interest Competition

Adam Smith was the first economist. In his book, The Wealth Nations (1776), Adam Smith explained how free markets functioned.

Markets are places where people can exchange the things they have for the things they want.

The Free Market In a free market economy, people are free to buy and sell whatever they want within the legal limits of the law. Obviously, we do not live in a completely free market economy. There are some restrictions on what we can buy and sell.

In the United States today, there are some products that we cannot legally buy. We can buy a rifle but not this gun.

Laissez-faire Laissez-faire is the doctrine that states that the government should not intervene in the marketplace. It means “let them do (as they please)”. In a free market, the government does not regulate the economy.

Adam Smith believed that an Invisible Hand existed or that the market would always fix itself.

will eventually produce it. The Invisible Hand is the idea that the economy fixes itself. If there is demand for a good that currently does not exist in the market, some enterprising entrepreneur will eventually produce it.

Adam Smith Adam Smith was the first person to explain how the free market functioned. He did not invent the free market rather he explained how it functioned. His book, The Wealth of Nations, is still considered a classic today.

Competition and self-interest allow markets to function effectively.

Competition and Self-Interest Competition is the struggle among producers for the dollars of consumers. Self-interest is acting on behalf of one’s personal gain. Competition and self-interest make markets work.

Competition leads to lower prices and better quality. When consumers have choices, producers must offer worthwhile products.

Every person has his or her best interest in mind. This photograph is an example. The tutor is interested in earning money and the student is interested in learning.

Questions for Reflection: Who was Adam Smith? How does a free market economy differ from a traditional economy? Define Laissez-faire. How does the market fix itself? How do competition and self-interest help the market function efficiently? What is the Invisible Hand?

A Centrally Planned Economy In this lesson, students will identify characteristics of a centrally planned economy. Students will be able to identify and/of define the following terms: Centrally Planned Economy Communism Problems of a Centrally Planned Economy

Karl Marx advocated a centrally planned economy in his book, The Communist Manifesto (1848).

In the early days of the Industrial Revolution, workers were exploited or mistreated. Children even worked in factories.

Sure, a few industrialists and capitalists Became very wealthy but…

Most people worked long hours for low wages in unsafe working conditions.

Karl Marx encouraged workers to unite and violently overthrow the Capitalist class in order to create a more just society.

“Workers of the world unite; you have nothing to lose but your chains.”

Marxism Marxism is frequently referred to as communism. Characteristics of a Marxist Society: Dictatorship Government ownership of the Factors of Production Economic Equality

It sounds like paradise: A society where there is no poverty, no want but…

Problems of a Centrally Planned Economy Many problems exist in centrally planned economies. The Problems of a Centrally Planned Economy: Workers lack incentive because all workers are rewarded equally. Productivity and efficiency decline. Innovation is not rewarded. Individual freedoms are sacrificed.

Would you work hard if you were rewarded Think about it! Would you work hard if you were rewarded The same as the lazy worker beside you?

Eventually, the Soviet Union collapsed and the formerly Communist republics began to transition to largely free market economies.

Transition has been difficult for Russia. A new economic perspective must be created and previously Government- owned factories must be privatized.

Questions for Reflection: How does a centrally planned economy differ from a free market economy? Who was Karl Marx and what did he advocate? Describe a Communist society. What problems are created by centrally planned economies? Define transition.

Modern Economies In this lesson, students will identify characteristics of modern economies. Students will be able to define and/or identify the following concepts and terms: Mixed Economy Laissez-faire Free Enterprise

Just as this apple is not perfect, economic systems are not perfect. While a centrally planned economy has many problems, a free market economy is far from perfect.

A Mixed Economy A mixed economy combines elements of different economic systems to meet the needs of the society. While modern economies are mixed, every mixed economy is slightly different from every other mixed economy. Some nations lean more towards central planning with some private ownership while other nations are predominantly free market with limited government intervention.

The Chinese communists seized power in 1949. However, today, the Chinese embrace elements of the free market.

The Chinese communists realized that workers needed incentives or reasons for increasing productivity.

The United States is a mostly free market economy. However, the government does intervene in the market.

It is important to remember that many abuses occurred in a totally free market. Child labor is one example of this abuse.

Laissez-faire Laissez-faire was the belief that the government should not intervene in the market. It meant “let them do (as they please).” It allowed businesses to operate without any restrictions.

Without government intervention, warning labels would not exist.

Heroin could be purchased in your local supermarket.

Government intervention protects our environment and our lives.

Free Enterprise The United States’ economic system is called the Free Enterprise system. A Free Enterprise system is a mostly free market economy with limited government intervention. The government does intervene in the economy when it is in the public interest.

So, modern nations have mixed economies. However, like milkshakes, mixed economies are not mixed the same. E. Napp

Questions for Reflection: Define a mixed economy. What problems are created by central planned economies? What problems are created by free market economies? Define Laissez-faire. What is the Free Enterprise system of the United States? E. Napp