© 2007 Thomson South-Western

Economic Systems

© 2007 Thomson South-Western What is an Economic System? It’s the method used by society to produce goods and services

© 2007 Thomson South-Western The Four Economic Systems Traditional Economy Market Economy Planned/Command Economy Mixed Economy

© 2007 Thomson South-Western Traditional Economy Relies on habit, custom, or ritual to make economic decision

© 2007 Thomson South-Western Market Economy Consumers and producers make the economic decisions

© 2007 Thomson South-Western Planned/Command Economy The government makes all of the economic decisions “We’ll fulfill five-year plan in four years!”

© 2007 Thomson South-Western Mixed Economy Economic decisions are made by both the government and consumers/producers.

© 2007 Thomson South-Western Economic Models

© 2007 Thomson South-Western Economic Models Economists use models to simplify reality in order to improve our understanding of the world. Two of the most basic economic models are: The Circular Flow Diagram The Production Possibilities Frontier

© 2007 Thomson South-Western Our First Model: The Circular-Flow Diagram The circular-flow diagram is a visual model of the economy that shows how dollars and resources flow through markets among households and firms.

© 2007 Thomson South-Western

Figure 1 The Circular Flow Model Spending Goods and services received Revenue Produced goods and services Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars Factors of production Wages, rent, and profit FIRMS HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Firms sell Households buy MARKETS FOR GOODS AND SERVICES

© 2007 Thomson South-Western Our Second Model: The Production Possibilities Frontier The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production (resources) and the available production technology.

© 2007 Thomson South-Western The Production Possibilities Frontier Production Possibilities Frontier A Quantity of Cars Produced 2, ,000 1,000 Quantity of Computers Produced The PPF shows you the maximum amount of resources you have for production If all resources were used, you can make 3,000 computers and 0 Cars. Or, you can make 1,000 cars and 0 computers

© 2007 Thomson South-Western The Production Possibilities Frontier B A Quantity of Cars Produced 2, , ,000 3,000 1,000 Quantity of Computers Produced C A= B= C= D= E= Production Efficiency Not possible! Underutilization E Efficiency & specialization in car production Brain Busta!!! D

© 2007 Thomson South-Western Our Second Model: The Production Possibilities Frontier Concepts illustrated by the production possibilities frontier Allocation of resources Opportunity cost Economic growth

© 2007 Thomson South-Western PPF Questions… B A Quantity of Cars Produced 2, , ,000 3,000 1,000 Quantity of Computers Produced D 1.What is the opportunity cost of moving production from point A to point B? 2.What is the opportunity cost of moving production from point D to point B? What can cause the PPF to shift?

© 2007 Thomson South-Western A Shift in the Production Possibilities Frontier Quantity of Cars Produced 2, , ,000 3,000 1,000 Quantity of Computers Produced A G What do you think would cause the PPF to shift this particular way? Something changed that caused there to be more resources in computer production.