1. Adam Smith’s Market Economy
AP Macroeconomics
Adam Smith’s Market Economy
Economic Logic of a Market System

2. All Economic Systems Allocate Resources
Market Command Traditional
Every Economic System has to answer 3 Questions:
1) What to Produce?
2) For whom to Produce?
3) How to Produce it? (or when to produce)

3. Which Economic System?
WHAT ECONOMIC SYSTEM?
Society will choose an economic system based on goals:
Economic Goals & Social Goals
Growth
Employment
Efficiency
Stability
Justice
Equality
Environment
Freedom

4. Adam Smith (1723-90) Founder of Free Market Economics
Argued: Free markets best promote the social welfare
Government should generally not interfere!
“The Wealth of Nations”
Published in 1776

5. "It is not from the benevolence of the butcher, the brewer, or
the baker, that we expect our dinner, but from their regard
to their own interest.”
“We address ourselves, not to their humanity but of
their advantages."
Adam Smith
Rule #1: Self-interest creates an incentive to work hard
Rule #2: Competition keeps us honest
End Result: An “invisible hand” will guide the economy
to the best market outcome for society.

6. Reading: The Free Market at Work
High
Prices
Scarce
Resources

7. Review Wealth Creation & Free Market
Please buy my Vulture
Scarce
Resources

8. Adam Smith & The Invisible Hand
People follow their own self-interest
Threat of competition keeps people honest
Markets naturally self-regulate
Invisible Hand
Government
should not
Interfere!
End result: low prices & many choices/options

9. HOW WHAT FOR WHOM MARKET SYSTEM Growth & Efficiency Supply & Demand
Market Economic System Summary
Production
HOW WHAT FOR WHOM
Growth &
Efficiency
Supply &
Demand
Price
MARKET
SYSTEM
Benefits Costs
Tremendous consumer choice
↑ career opportunity
Unlimited Upside ($)
Strong incentive to innovate
Low prices & high quality
Creates wealth
Generally self-regulates
High Stress
↑ incentive to cheat
↑ inequality (rich-poor gap)
↑ environmental impact

10. Command Econ Systems Soviet Union “adopts” command economic system
Karl Marx
1848
Soviet Union “adopts” command economic system
i.e. communism
General Philosophy:
Government controlled economy (centrally planned)
stressed equality & the common good (collective society)
Economic Incentive to innovate, work hard ?
Work hard for the “collective” good of society
Shortage of a good => what happens?

11. Self-Regulation vs. Central Planning
Market Economy
Command Economy
Shortage of
A Good?
Invisible Hand

12. Economic Systems Trade-offs
Efficiency vs. Equity
Free markets systems focus on efficiency
Command systems focus on equity
Efficiency means society gets the most from its scarce resources
Equity means the benefits of scarce resources are distributed fairly in society (not necessarily equally!) 9

13. HOW WHAT FOR WHOM MARKET COMMAND TRADITIONAL Growth & Efficiency
3 Questions for each Economic System
HOW WHAT FOR WHOM
“to produce” “to produce” “to produce”
Economic System
Growth &
Efficiency
Supply &
Demand
Price
MARKET
Equality
Gov’t or
Central Planner
Employment
COMMAND
Need
[Tradition]
Need/
Necessity
Stability
TRADITIONAL

14. Crash Course Economics Video: Economic Systems (10 minutes)
Market Systems vs. Command Systems

15. Traditional Economic System
Designed to preserve culture of society
Change occurs very slowly
Gov’t uses strict laws to enforce behavior
CHINA

16. Bhutan Video: Traditional Economy
Gross
National
Happiness
6 minutes

17. Bhutan June 2011
Typical Village
Largest City
Music Video

18. Summary Market systems stress competition
Work “individually” in your own “self interest”
Invisible hand regulates economy
Command systems stress equality
Work “collectively” for the common good
Government centrally plans economy
Traditional systems stress preservation of culture
Government maintains culture of society
Stability more important than efficiency

19. Bhutan June 2011
Typical Village