Chapter 2SectionMain Menu Answering the Three Economic Questions What key economic questions must every society answer? What basic economic goals do societies have? What types of economic systems exist today?

Chapter 2SectionMain Menu The Three Economic Questions Every society must answer three questions: –What goods and services should be produced? –How should these goods and services be produced? –Who consumes these goods and services?

Chapter 2SectionMain Menu Economic Goals Making the most of resourcesEconomic efficiency Freedom from government intervention in the production and distribution of goods and services Economic freedom Assurance that goods and services will be available, payments will be made on time, and a safety net will protect individuals in times of economic disaster Economic security and predictability Fair distribution of wealthEconomic equity Innovation leads to economic growth, and economic growth leads to a higher standard of living. Economic growth and innovation Societies pursue additional goals, such as environmental protection. (at what cost?) Other goals Economic Goals Societies answer the three economic questions based on their values.

Chapter 2SectionMain Menu An economic system is the method used by a society to produce and distribute goods and services. Four Economic Systems Traditional economies rely on habit, custom, or ritual to decide what to produce, how to produce it, and to whom to distribute it. In a centrally planned OR COMMAND economy the central government makes all decisions about the production and consumption of goods and services. In a market economy economic decisions are made by individuals and are based on exchange, or trade. Mixed economies are systems that combine tradition and the free market with limited government intervention.

Chapter 2SectionMain Menu The Free Market How do free markets operate? How can markets regulate themselves? What are the advantages of a free market economy?

Chapter 2SectionMain Menu Markets exist because none of us produces all the goods and services we require to satisfy our needs and wants. A market is an arrangement that allows buyers and sellers to exchange goods and services. Examples: Walmart, City market, etc. Specialization is the concentration of the productive efforts of individuals and firms on a limited number of activities. Examples: Accountant, Quarterback, etc Why Do Markets Exist?

Chapter 2SectionMain Menu monetary flow physical flow monetary flow physical flow Circular Flow Diagram of a Market Economy Households Firms Product market Factor market Households pay firms for goods and services. Firms supply households with goods and services. Households supply firms with land, labor, and capital. Firms pay households for land, labor, and capital. The Free Market Economy In a free market economy, households and business firms use markets to exchange money and products. Households own the factors of production and consume goods and services.

Chapter 2SectionMain Menu The Market’s Self-Regulating Nature In every transaction, the buyer and seller consider only their self-interest, or their own personal gain. Self- interest is the motivating force in the free market. Producers in a free market struggle for the dollars of consumers. This is known as competition, and is the regulating force of the free market. The interaction of buyers and sellers, motivated by self- interest and regulated by competition, all happens without a central plan. This phenomenon is called “the invisible hand of the marketplace.”

Chapter 2SectionMain Menu Adam Smith Adam Smith propounded a theory of economic development that is still influential today. –“Economies will grow if they have the right kind of government.” Smith was a prominent member of the Scottish enlightenment. –Born in Kirkcaldy 5 June 1723 –Kidnapped by ‘tinkers’ at age of three –School in Kirkcaldy –1737—University of Glasgow

Chapter 2SectionMain Menu Adam Smith

Chapter 2SectionMain Menu Adam Smith Smith’s lectures included: Ethics –Published as Theory of Moral Sentiments, 1759 –Traces moral sentiments to sympathy (ability to put oneself in someone else’s situation). Evolution of jurisprudence treated historically and related to economic growth State policy as it is related to national prosperity

Chapter 2SectionMain Menu Adam Smith Smith’s famous work was An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 Nature? Not the accumulation of precious metals but the standard of living of the population Causes? Ultimately reduced to the right state policy

Chapter 2SectionMain Menu Adam Smith Analysis of the Wealth of Nations starts from an unusual premise. Theory of Moral Sentiments assumed people had ‘sympathy’ for other human beings. Wealth of Nations assumes people are selfish. Moralists usually condemned this, but Smith argued that it is socially useful:

Chapter 2SectionMain Menu Adam Smith “It is not from the benevolence of the butcher, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages.” Smith argued that the pursuit of self-interest increased prosperity generally by making the market system work.

Chapter 2SectionMain Menu Adam Smith Each individual seeks “only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention…By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” also known as laissez-faire

Chapter 2SectionMain Menu Adam Smith Self-interest can be harnessed to promote general prosperity by creating appropriate institutions. The state should promote free exchange and secure property. Two avenues lead these policies to increase prosperity Raising productivity through the division of labour Raising investment

Chapter 2SectionMain Menu Adam Smith Smith thought the legitimate functions of the state were: National defense Establish property rights Establish legal system Promote free trade Invest in trade-promoting infra-structure –Laissez faire, describes this policy orientation.

Chapter 2SectionMain Menu Adam Smith Now that we understand Smith’s model, we can ask what it explains. Smith thought Europe was more prosperous than China. – How does he account for the lead? – Was he right? Does Smith’s model explain why England industrialized before France?

Chapter 2SectionMain Menu Adam Smith Smith thought that China lagged behind Europe because the Chinese empire did not follow his policies. Foreign trade was restricted. ‘oriental despotism’ meant that property was insecure. “China seems to have been long stationary, and had probably long ago acquired that full complement of riches which is consistent with the nature of its laws and institutions. But this complement may be much inferior to what, with other laws and institutions, the nature of its soil, climate, and situation might admit of” (1776/1937: 95)

Chapter 2SectionMain Menu Adam Smith China gained from a large internal market but was hurt by limits on foreign trade. –European ships were only allowed to trade in Canton. Here are their warehouses. “A country which neglects or despises foreign commerce, and which admits the vessels of foreign nations into one or two of its ports only, cannot transact the same quantity of business which it might do with different laws and institutions” (1776/1937: 95).

Chapter 2SectionMain Menu Adam Smith How true is Smith’s assessment of China? This is currently the subject of vigorous debate. Revisionists have argued that Chinese incomes were just as high as European in the eighteenth century. Chinese foreign trade was actually extensive? Some historians deny that Chinese property was insecure. Some economist claim that Chinese markets worked as efficiently as European markets.

Chapter 2SectionMain Menu Advantages of the Free Market Economic Efficiency As a self-regulating system, a free market economy is efficient. Economic Growth Because competition encourages innovation, free markets encourage growth. Economic Freedom Free market economies have the highest degree of economic freedom of any economic system. Additional Goals Free markets offer a wider variety of goods and services than any other economic system.

Chapter 2SectionMain Menu Centrally Planned/ Command Economies How are centrally planned economies organized? How did the centrally planned economy of the former Soviet Union function? What problems exist within centrally planned economies?

Chapter 2SectionMain Menu In a centrally planned economy, the government owns both land and capital. The government decides what to produce, how much to produce, and how much to charge. Socialism is a social and political philosophy based on the belief that democratic means should be used to distribute wealth evenly throughout a society. Communism is a political system characterized by a centrally planned economy with all economic and political power resting in the hands of the government. Organization of Centrally Planned Economies

Chapter 2SectionMain Menu The Former Soviet Union Soviet Agriculture –In the Soviet Union, the government created large state-owned farms and collectives for most of the country’s agricultural production. Soviet Industry –Soviet planners favored heavy-industry production (such as steel and machinery), over the production of consumer goods. Soviet Consumers –Consumer goods in the Soviet Union were scarce and usually of poor quality.

Chapter 2SectionMain Menu Problems of a Centrally Planned Economy Centrally planned economies face problems of poor- quality goods, shortages, and diminishing production.

Chapter 2SectionMain Menu Modern Economies Why are many modern economies mixed economies? What role does the government play in a mixed economy? How do mixed economies in different countries compare? What role does free enterprise play in the United States economy?

Chapter 2SectionMain Menu Market economies, with all their advantages, have certain drawbacks. The Rise of Mixed Economies Limits of Laissez Faire Laissez faire is the doctrine that government generally should not interfere in the marketplace. Governments create laws protecting property rights and enforcing contracts. They also encourage innovation through patent laws.

Chapter 2SectionMain Menu monetary flow physical flow monetary flow physical flow Circular Flow Diagram of a Mixed Economy Households Firms Product market Factor market Government expenditures government- owned factors taxes government purchases Government’s Role in a Mixed Economy In a mixed economy, The government purchases land, labor, and capital from households in the factor market, and Purchases goods and services in the product market.

Chapter 2SectionMain Menu Continuum of Mixed Economies Centrally plannedFree market Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick Iran North Korea Cuba China RussiaGreecePeruUnited States South AfricaFranceUnited Kingdom BotswanaCanadaSingapore Hong Kong Comparing Mixed Economies An economic system that permits the conduct of business with minimal government intervention is called free enterprise. The degree of government involvement in the economy varies among nations.

Chapter 2SectionMain Menu Government regulation Should the government be allowed to regulate conditions, policies, and protocol within public and private institution?

Chapter 2SectionMain Menu Review the Chart below and explain what information it holds.

Chapter 2SectionMain Menu Government Regulation In what ways does government regulation effect the United States?

Chapter 2SectionMain Menu Government Regulation Do you agree that the government should regulate businesses and practices?

Chapter 2SectionMain Menu Government regulations

Chapter 2SectionMain Menu Government Regulation

Chapter 2SectionMain Menu Government DEregulation Government deregulation has also occurred over the years which has led to better, competitive prices in some areas of our market. What are some benefits to government deregulation?

Chapter 2SectionMain Menu What are the disadvantages to Government regulations? What are the disadvantages to deregulation?

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