WHO ANSWERS THE THREE ECONOMIC QUESTIONS? IF YOU KNOW THIS, YOU KNOW WHAT KIND OF ECONOMIC SYSTEM YOU ARE LIVING UNDER! * pay attention to the headings on each slide…don’t ignore them * Chapter 2 Economic Systems

Three Economic Questions What goods and services should be produced? How should these goods and services be produced? Who benefits from these goods and services?

What Goods and Services Should be Produced? WHAT is an item that is over-produced in our economy? WHAT is an item that is under-produced in our economy? underproduced overproduced

What Goods and Services Should be Produced? Obviously we all need food and shelter, but there is a standard of living that is expected--so we have to decide what to produce to meet that standard. vs. Standard of living = the quality of life based on the ownership of necessities and luxuries that make life easier.

What Goods and Services Should be Produced? Recall Guns vs. Butter. How much is needed with respect to military spending? How much is wanted?

How Should Goods and Services Be Produced? HOW Questions must be answered, such as: Should we produce energy with oil or solar power? Should teachers have classes of 20 or 50? Should we have corporate farms or small family farms?

For Whom to Produce? The answer to the question of distribution (FOR WHOM to Produce?) is determined by how societies choose to distribute income. Who gets the income? …the ones who supply Land, Labor, Capital, and Entrepreneurship!

Factor Payments Factor payments are the income people receive for supplying the factors of production (L,L,C & E).  Land owners receive rent

Factor Payments? Factor payments are the income people receive for supplying the factors of production (L,L,C & E).  Land owners receive rent  Laborers receive wages

Factor Payments Factor payments are the income people receive for supplying the factors of production (L,L,C & E).  Land owners receive rent  Laborers receive wages  money lenders receive interest payments

Factor Payments Factor payments are the income people receive for supplying the factors of production (L,L,C & E).  Land owners receive rent  Laborers receive wages  money lenders receive interest payments  Entrepreneurs receive profits minus income expenses = profit

Economic Goals reflect Societal Values The United States, Saudi Arabia, and Cuba answer the 3 economic questions differently, based on the importance they attach to various economic goals. Cuba doesn’t value the same things we do, so their economy reflects their values, not ours.

Economic Efficiency Since resources are always scarce, using them always involves opportunity costs. If a company chooses to produce gas-guzzling SUVs when society wants Hybrids, the company is operating inefficiently. If a society can accurately assess what to produce, it increases economic efficiency!

Economic Freedom Nations have different economic systems. Each system allows different degrees of economic freedom. Some nations don’t allow the purchase or possession of particular items. Some nations don’t allow entrepreneurship.

Economic Security and Predictability Security: Most nations believe in providing some sort of safety net to help citizens in need: examples would be the elderly, the sick, & those who have lost jobs through no fault of their own. Predictability: Most people also have the expectation that there will be food at the grocery store and fuel at the gas station when they need.

Economic Equity Societies have to decide how to divide the economic pie. Should everyone get the same portion or should some people’s piece be bigger? Many people believe in equal pay for equal work. Lawyers make more than teachers, doctors make more than secretaries.

Economic Growth and Innovation A nation’s economy must grow for a nation to improve its standard of living, especially if the population is growing!

Economic Growth and Innovation Innovations in technology foster increases in efficiency. (More technology = more efficiency in making goods) Nomads Agriculture Age Industrial Revolution Information Age.

Additional Goals Societies may have more goals than what we have talked about already, such as: Environmental Protection Full Employment Universal [Everyone Gets] Medical Care Every nation must prioritize its economic goals…they all come with trade-offs.

Economies and Values 4 different systems have been developed to address the 3 economic questions. Each system is a reflection of the society’s values. Try to figure out what each one values most.

System 1: Traditional Economies Resources (economic decisions) are distributed by inheritance Social network gives everyone a purpose & function in society habit, rituals, & customs dictate decisions Revolves around family; work is divided by gender lines. Hunting & agriculture lie at the heart of lives & laws Less demand on the earth’s resources; goods are only produced if they are going to be consumed

System 1: Traditional Economies No over-production or surpluses most of the time; living at subsistence level (everyone has what they need, but not a lot more). Very few things in place to deal with disaster Most have no modern conveniences and have a low standard of living Very resistant to change, because no desire for goods the rest of the world has--they have no value in this lifestyle (except possibly for the younger generation!)

System 1: Traditional Economies Goals of a traditional economy are:  1. Full employment (everyone works)  2. Price stability (no inflation)  3. Satisfactory rate of economic growth (generally have as much or more than usual)  4. Free trade with other nations (or tribes)  5. Correct (fair) distribution of income  6. Efficient allocation of resources (no wasting time) Examples: the Amish in midwestern America, the Eskimos in Alaska, the Masai tribe in Kenya and Tanzania…everyone before the Industrial Revolution

System 2: Market Economies Economic decisions are made by individuals with no rules imposed on them by the government. Individuals determine what gets made and how and who profits from it Also called “free markets” or “capitalism” Examples…?

System 2: Market Economies Examples: …guess what! There are no pure market economies. The government always imposes SOME rules. The closest thing to free market economies in the world are:  the United States  the United Kingdom  Germany  Netherlands  Canada

System 3: Command Economies In a centrally planned economy the government COMMANDS everything. The central government owns all the factors of production (anything productive: land, mines, buildings, businesses, forests…) The central government makes all of the decisions on how to answer the three questions. Examples…?

System 3: Command Economies Examples include: the FORMER Soviet Union, and the CURRENT Cuba, North Korea, and Vietnam. What do these countries have in common?….

System 3: Command Economies Examples include: the FORMER Soviet Union, and the CURRENT Cuba, North Korea, and Vietnam. What do these countries have in common?….  They are communist countries. Under communism, the government dictates what is made, who is making it, at what price it will sell, and to whom it is sold.

System 4: Mixed economy Most modern economies fall in this “Mixed” category: market-based economic systems in which the government plays a role. The government usually “plays a role” by…

System 4: Mixed economy Most modern economies fall in this category: market-based economic systems in which the government plays a role. The government usually “plays a role” by…  Regulating industries (such as…)

System 4: Mixed economy Most modern economies fall in this category: market-based economic systems in which the government plays a role. The government usually “plays a role” by…  Regulating industries (such as…)  Regulating minimum wage

System 4: Mixed economy Most modern economies fall in this category: market-based economic systems in which the government plays a role. The government usually “plays a role” by…  Regulating industries (such as…)  Regulating minimum wage  Imposing taxes (such as…)

System 4: Mixed economy Most modern economies fall in this category: market-based economic systems in which the government plays a role. The government usually “plays a role” by…  Regulating industries (such as…)  Regulating minimum wage  Imposing taxes (such as…)  Imposing tariffs

System 4: Mixed economy Most modern economies fall in this category: market-based economic systems in which the government plays a role. The government usually “plays a role” by…  Regulating industries (such as…)  Regulating minimum wage  Imposing taxes (such as…)  Imposing tariffs  Imposing quotas

System 4: Mixed economy Most modern economies fall in this category: market-based economic systems in which the government plays a role. The government usually “plays a role” by…  Regulating industries (such as…)  Regulating minimum wage  Imposing taxes (such as…)  Imposing tariffs  Imposing quotas  Regulating working conditions

Why Do Markets Exist? Markets are a way to exchange what we have for what we want/need. None of us are self sufficient. You did not grow the cotton to make your shirt. You did not grow the wheat to make the bread for your sandwich.

Specialization Rocks! Instead of doing everything ourselves, we specialize in one or a few products. This makes us more efficient. I do not want to calculate my own taxes. I do want to teach. I specialize in teaching and someone else specializes in tax law. I pay them to calculate my taxes, and they pay taxes so I can teach their kids.

Buying and Selling The typical person makes what they specialize in, sells it and then uses those wages to buy what they want/need.

The Self-Regulating Nature of the Marketplace Why is it that firms and households cooperate in order to get what they need?

Greed is Good Why is it that firms and households cooperate in order to get what they need? Competition! Self-interest! … make everything work out.

Adam Smith is brilliant Adam Smith called this “THE INVISIBLE HAND.” He said…competition is good! Greed is good! Self- interest is good! In The Wealth of Nations, he wrote that in an economy, there are countless individual transactions. In each single transaction, the driving force is each person’s consideration of their own personal gain.

Competition and Self-Interest Everyone’s self-interest is the regulating force that balances an economy:

The circle of life…I mean economics Everyone’s self-interest is the regulating force that balances an economy:  Individuals are trying to get the most for their money,

The circle of life…I mean economics Everyone’s self-interest is the regulating force that balances an economy:  Individuals are trying to get the most for their money,  Firms are trying to make the most profit.

The circle of life…I mean economics Everyone’s self-interest is the regulating force that balances an economy:  Individuals are trying to get the most for their money,  Firms are trying to make the most profit.  Firms will compete with each other for sales.

The circle of life…I mean economics Everyone’s self-interest is the regulating force that balances an economy:  Individuals are trying to get the most for their money,  Firms are trying to make the most profit.  Firms will compete with each other for sales.  This competition drives prices down.

The Invisible Hand Adam Smith said that the economy decides on production and price without any central regulation. Each individual consumer or individual firm trying to get the best for itself will set proper production amounts and prices. [No one will produce what someone won’t buy! No one will sell at a price consumers won’t pay!] Adam Smith called this the INVISIBLE HAND.

Advantages of the Free Market Economic efficiency (no one will waste their own time or money) Economic freedom (no one telling you what to do) Economic growth (if I make more profit, I will buy more goods with it) Despite the advantages, it doesn’t exist anywhere!…on a large scale. No government can completely stay out of it. Why is that?!?!?!?

How are Command Economies organized? Government Control of resources and production  Government owns both land and capital  Government decides  What to produce  How much to produce  How much to charge

Socialism Socialism- The goal is to distribute wealth evenly, and the decisions are made by the citizens, democratically.  Can be a democracy, but still centrally planned  Government owns major industries like utilities

Communism The goal is to distribute wealth equally, but the people are not trusted to do it. Therefore, the government makes all the decisions of how to distribute the wealth. All economic and political power lies in the central government. Government is authoritarian in nature No individual freedom (or very little) Usually dominated by single political leader

The Former Soviet Union Example of communism: the U.S.S.R. (fell in 1991) Allocated best land and capital to the military and space program The Soviet government was responsible for deciding the process (what, how, for whom) for 24 million goods

Soviet agriculture Farmers worked for daily wage Government provided equipment, seed, fertilizer Collectives were formed  Large farm leased to peasant farmers  Required to produce what the government told them to  No incentive to produce better crops (couldn’t keep the profit)

Soviet industry Planners favored the defense industry (GUNS over BUTTER) Consumer goods got the leftover resources Jobs were guaranteed…so no incentives given for good work (you couldn’t get fired; the government might reassign you but you always had a job) Illegal to be an entrepreneur

Soviet Consumers What was it like for the people? Goods scarce and poor quality Focus on quantity, not quality Vast housing shortages Vast food shortages

Problems with Command Economies Since there are no incentives, growth is nearly impossible System can’t meet consumers’ needs or wants Discourage change Discourage innovation Decisions are over-complicated

Why Mixed Economies? Limits of Laissez Faire (hands off)

Why Mixed Economies? Limits of Laissez Faire (hands off)  Market economies are great, but have limitations

Why Mixed Economies? Limits of Laissez Faire (hands off)  Market economies are great, but have limitations  If there is no government intervention, where do schools and roads, police and disaster relief come from?

Why Mixed Economies? Limits of Laissez Faire (hands off)  Market economies are great, but have limitations  If there is no government intervention, where do schools and roads, police and disaster relief come from?  Laws are created protecting rights and contracts

Balance of Freedom and Control: A Mixed Economy Some goals are better met by governments:  Can you think of some examples? Some are better met by the free market:  Can you think of some examples?

Economic Terms Profit Loss

Profit minus income expenses = profit

Loss If minus income expenses is less than zero, then you have a LOSS instead of a PROFIT

Government Regulation Minimum Wage

Social Programs Social Security being on a “fixed income”

Economic Terms Inflation

Economic Terms Private Property Rights

Economic Terms Competition