Economic Systems

Three Economic Questions What goods and services will be produced? How will they be produced? For whom will they be produced? By applying these three questions to different countries, you can gain insight about these societies. Every economic system revolves around these three questions

Distinguishing among systems 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

Pure Market Economy All resources are privately owned Economic activity is based on the prices that are generated in free, competitive markets (this includes voluntary exchange) which encourages inventions and innovations Price is determined by unrestricted supply and demand any income derived from selling resources goes exclusively to each resource owner

Adam Smith Laissez Faire economics: no government interference Believed market forces coordinate production as if by an “invisible hand” which he wrote about in his book Wealth of Nations Means that a true market naturally leads to efficient results and will correct any inequalities in resource allocation

Problems Difficulty enforcing property rights (NO govt. involvement) Some people have few resources to sell Some firms try to monopolize markets No public goods (costs and benefits that are shared by everyone, public parks) Externalities (effects on third parties or from outside sources)(Pos. – vaccinations, Neg. – pollution, natural disasters)

U.S. Market Economy (Capitalism) Buyers and sellers come together to answer the three fundamental economic questions (through voluntary exchange), and own the factors of production Supply: sellers determine what good or service to produce and part with at different price levels Producer supplies goods and services with profit as incentive Demand: buyers determine how much of a good or service they are willing to buy at different price levels Consumers buy the goods and services with the cheapest price as the incentive, competition, freedom of choice

Problems Less security because it does not have a plan for distribution of wealth (unless the govt. steps in) Explains why there are extremely rich and extremely poor Greater risk of business failure Little govt. regulation or control which does not guarantee jobs or income

Role of Government in Market-Economy Provides public goods (national defense, police and fire protection) paid for through taxes Redistributes income (taxes, welfare programs) Resolves market failures (New Deal programs) Anti-trust laws – used by the government to prevent business from setting prices (monopolies) Tariffs (tax on foreign imports) Subsidies (government assistance/money paid to businesses) Transfer payments (social security, Medicare, Medicaid) Consumer protection laws Protection of property rights (patents) Deregulation of an industry (airlines in 1970s)

Command Economy (Central Planning) Opposite of market economy (Cuba, former Soviet Union) Government commands all markets Govt. decides what, how, and for whom (owns factors of production), allows for more equal distribution of wealth Since govt. is in charge of everything, citizens should receive equal amounts of basic goods and services; however it often leads to scarcity of needs (bread) or public goods and surplus of unnecessary goods Govt. provides for its citizens (job security but no advancement) Consumer and personal freedoms are not great

Problems Private ownership is minimal Consumers get low priority Little freedom of choice Little profit motive Can be inefficient (slow to react to demand) Resources owned by the state are sometimes wasted Environmental damage (industrialization) Does not reward hard work or special skills, no incentives

Traditional Economy Production is based on customs and tradition Status quo – if something worked for one generation, it will work for the next May slow down economic progress and growth Survival is based on subsistence agriculture (farming) Little opportunity for economic advancement

Mixed Economy Have elements of more than one system **Most economies are mixed** China combines elements of market and command economies U.S. has a mixed economy, capitalistic with limited government involvement (taxes, regulations) Government produces public goods (roads) and private firms produce consumer goods (final use) The government regulates the private sector and provides equal opportunity by protecting private property

Transitional Economy Is in the process of shifting from central planning to competitive markets Involves converting state-owned enterprises into private enterprises – privatization (collapse of communism under the Soviet Union)