Chapter 2 Economic Systems

Types of Economic Systems how society uses resources to satisfy people’s wants Three basic systems: Traditional Command market economies

Types of Economic Systems Traditional Economy centers on families, clans, or tribes decisions are based on customs and beliefs Good of the group always comes before individual desires

Characteristics of Traditional Economies Advantages and Disadvantages Advantages: little disagreement over goals, roles methods of production, distribution determined by custom Disadvantages: as result of resistance to change, less productive do not use new methods; people not in jobs they are best suited for low productivity results in low standard of living

Types of Economic Systems cont. Command Economy (centrally planned economy) government makes economic decisions determines what to produce; how to produce; who gets products determines who is employed, work hours, pay scales Wants of individual consumers rarely considered Government owns means of production: resources and factories

Government Controls EXAMPLE: Socialism and Communism Karl Marx influenced some societies to adopt command economies socialism—government owns some of the factors of production communism—no private property; little political freedom Authoritarian system requires total obedience to government communism is authoritarian socialism

Karl Marx: Economic Revolutionary A New View of Economics Marx lived during Industrial Revolution Argued factory owners used workers as resource exploited workers by keeping wages low to increase profits workers would rebel, establish classless society Wrote The Communist Manifesto (with Friedrich Engels), Das Kapital

Government Controls Socialism and Communism Democratic socialism established under democratic political process government owns basic industries other industries private central planners make decisions for government-owned industries central planners might control other sectors, such as health care

Command Economies Today No pure command economies today modern telecommunications bringing about change Some economies still have mostly command elements

Command Economies Today North Korea Communist North Korea used resources for military, not necessities built large army; nuclear weapons program In 1990s and early 2000s, millions died of hunger, malnutrition In 1990s, production decreased and economy shrank Since 2003, some market activity allowed

Command Economies Today Impact of Command Economies In theory, command systems fair to everyone; In practice, many disadvantages central planners do not understand local conditions workers have little motivation to be productive or conserve resources artificially low prices lead to shortages people sacrificed to carry out centrally planned policies

Types of Economic Systems cont. Market Economy driven by choices of consumers and producers consumers spend money, go into business, sell their labor as they wish producers decide how to use their resources to make the most money Consumers, producers benefit each other when they act in self-interest

Fundamentals of a Market Economy 1: Private Property and Markets 2:Limited Government Involvement Laissez faire—government should not interfere in economy Capitalism—system having private ownership of factors of production says producers will create products consumers demand Actual market economies all have some government involvement

Fundamentals of a Market Economy 3: Voluntary Exchange in Markets Voluntary exchange—traders believe they get more than they give up 4: Competition and Consumer Sovereignty Consumer sovereignty—buyers choose products, control what is produced Competition controls self-interested behavior sellers offer low price or high value to please consumers, make profit

Fundamentals of a Market Economy 5: Specialization and Markets Specialization—people concentrate their efforts in the activities they do best encourages efficient use of resources leads to higher-quality, lower-priced products

Circular Flow in Market Economies KEY CONCEPTS Circular flow model illustrates how interactions occur in a market Represents the two key decision makers: households, businesses Shows the two markets where households and businesses meet goods and services resources

Circular Flow in Market Economies Factor Markets Factor market—market for the factors of production land, labor, capital, entrepreneurship Product Markets Product market—market where goods and services bought and sold includes all purchases by individuals from businesses Circular flow model shows how market economies operate

Teal- flow of resources and products Green- Flow of $$

Impact of Market Economies Advantages Individuals free to make economic choices, pursue own work interests Less government control means political freedom Locally made decisions mean better use of resources, productivity Profit motive ensures resources used efficiently, rewards hard work resulting competition leads to higher-quality, more diverse products

Impact of Market Economies Disadvantages Pure market economy has no way to provide public goods and services Does not give security to sick or aged During U.S. industrial boom, business owners rich, workers low pay Businesses did not address problems caused by industrialization Industrialized societies adopt some government control of economy

Today’s Mixed Economies Mixed economy has elements of traditional, command, market systems most common type of economic system Traditional, command, market economies adopt elements from others

Today’s Mixed Economies Life in a Mixed Economy Family farming in U.S. serves as example of mixed economy traditional: all members of family help bring in harvest command: affected by government—public school, roads, Social Security market: own land, sell their products in competitive market

Today’s Mixed Economies Types of Mixed Economies U.S. basically has market system European countries greater mix of market and command elements France—government controls some industries; provides social services Sweden—state owns part of all companies; lifelong benefits, high taxes Namibia—traditional; state supports market, foreign investment

Trends in Modern Economies Changes in Ownership Nationalize is to change from private to government ownership Privatize is to change from government to private ownership