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Three major questions Basic Goals 4 systems
Economic Systems Three major questions Basic Goals 4 systems CH 2.1
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Three Key Questions Economic system - the method used by a society to produce and distribute goods and services Three questions need to be answered 1. What goods and services should be produced? 2. How should they be produced? 3. Who consumes the goods and services?
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1. What goods should be produced?
How do we separate needs and wants We need food/shelter What about the things we want? What do we do with our other resources? Military spending Education Health care Consumer goods (which ones?) Guns or butter Limited resources, each decision comes with an opportunity cost What are we willing to sacrifice?
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2. How should they be produced?
Hydroelectric Oil Solar Power Nuclear Food Large commercial farms or subsistence farming However the decision is made, it will require land, labor and capital How these are combined are also important Investments in technology
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3. Who is going to consume the goods and services produced?
Luxury items or basic necessities Depends on income of society Factor payments are income that people receive for supplying factors of production Land = Rent / Labor = Wages / Capital = Interest Entrepreneurs = Profits Societies answer this question differently depending on their goals Make lots of money for a few Provide for population and increase standard of living
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Economic Goals Economic Efficiency Make the most of resources
Cuts waste Economic Freedom Freedom from Govt intervention in the production and distribution of goods and services Child labor laws Substance control laws Federal Minimum wage Economic security and predictability 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 Goods will be available Paychecks will be there Safety Nets Economic Equity Fair distribution of wealth Equal pay for equal work Growth and innovation Innovation leads to growth, and growth leads to higher standard of living (level of economic prosperity) New jobs and income New technology increases efficiency Other Goals Societies pursue other goals as well Environmental Protection Full employment Universal Health Care
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Four Economic Systems 1. Traditional Economy
Relies on habit, custom or ritual to decide what to produce, how to produce it and whom to distribute it to Not much room for change Family centered with clear gender roles Usually small and close Slow to adopt new technologies Generally a low standard of living
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2. Market Economies Decisions are made by individuals and are based on exchange or trade Also called free markets or capitalism
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3. Centrally Planned Economies
The central government decides how all three questions are answered Also known as Command Economies
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4. Mixed Economies Combination of traditional, Market and Centrally planned economies Most modern Economies are mixed economies
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The Free Market Ch 2.2 Why do markets exist
Free market economy analysis Self regulation of market Advantages
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Markets exist because no one is totally self sufficient
Market - an arrangement that allows buyers and sellers to exchange things Markets exist because no one is totally self sufficient Specialization- A concentration of the productive efforts of individuals and firms on a limited number of activities Very Efficient
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Why is it called a free market?
They are based on voluntary exchanges There is an exchange of money and products Privately owned businesses - what to make Individuals - what to buy Individuals answer the 3 questions
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Within the Free Market Households and Firms Households
A person or group of people living in the same residence Households own the factors of production Land, labor and capital They are also the consumers Firms are organizations that use resources to produce a product, which it then sells Transforms inputs into outputs
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Circular Flow Diagram PAYMENT WORK Firm H SALARY GOODS Factor Market
Where firms purchase the factors of production Product Market Where products are purchased by Households PAYMENT WORK Firms supply goods and services Firms pay for Land, labor and capital Firm H Households pay for goods and services SALARY GOODS Households supply land, labor and capital Physical Flow Monetary Flow
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Self Regulation of free market is controlled by:
**Self Interest and Competition** Self interest - we only look out for our own personal gain The motivating force of the market Competition Incentive to look for lower price Competition is the struggle between producers for the dollars of the consumers The regulating force of the free market These factors work together to regulate the market without any direction from the Govt ONE MAN BAND
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Adam Smith and the Invisible Hand
Wealth of Nations 1776 Competition causes more production and moderates higher prices Consumers get goods that reflect the cost of producing them Laissez Faire – “let them do as they please” Government must leave individuals as free as possible to pursue their own interests This will produce more jobs and more goods/services
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Advantages to the free market
1. Efficient - produce only what is wanted at prices that consumers will pay 2. Freedom - work where you want, make what you want, buy what you want 3. Growth - constantly looking for innovations that will increase production
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Wider variety of goods than any other system
Consumer Sovereignty - consumers essentially decide what gets produced
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Although there are many advantages to a free market economy, no true free market economy exists
Lack of economic equity Lack of economic security
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CH 2.3 Command Economies Organization of Centrally Planned Economies
Analysis of former Soviet Union Problems associated with Centrally Planned Economy
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Organization Centrally planned economies are the complete opposite of free markets Govt’s control everything - 3 Q’s After gathering information, bureaucrats tell firms what and how much to make Distribute goods to the firms - must ensure there is enough Govt owns the land and the capital, By controlling where people work, they essentially control the labor too (also control wages)
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Govt directs the resources to the firms and tells them to produce a certain amount
Farmers are told what to plant, where to plant and who to sell their goods too No competition, no self interest Puts limits on the amount of goods available
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Socialism vs. Communism
Socialism - social and political philosophy based on the belief that democratic means should be used to evenly distribute wealth throughout society Real equality can only exist with political and economic equality Major utilities are often owned by Govt Since people elect the govt officials - they work in the name of the people
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Communism - Centrally planned economy with ALL the economic and political power resting in the hands of the central govt They believe a socialist society can only come about after a violent revolution Karl Marx, Friedrich Engels, and Vladimir Lenin Introduced in 1848 by Marx and Engels, 1917 Lenin and Bolsheviks took charge of Russia Authoritarian rule prevents freedom of judgment and action Historically dominated by a single party or ruler
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Former Soviet Union Operated from 1920s through 1991
Wanted to impress the World Gave the best land, labor and capital to armed forces, space program and production of capital goods (Farms and factories)
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Agriculture State run farms called collectives
State provides all the equipment, seeds and fertilizer State sets daily wage rates State leases land from peasants Either through food or funds Guaranteed income and employment No incentive to make more or better crops Eventually could not feed their own people
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Industry Factories also owned by State
Favored Defense and Heavy Industry Production of machines used in other industries Concentration of resources Again no incentives Why work hard, innovate? Entrepreneurial behavior was ILLEGAL
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Consumers Goods were scarce and poor quality Quantity not quality
Stores had to accept goods produced No alternatives Long lines Housing shortage
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Problems Can be good - kick start an economy, jobs and income HOWEVER:
Stalin’s 5 year plans HOWEVER: Can’t meet needs and wants of consumers No incentive to work hard Little or no innovation Crime - Black Market Almost always falls short of ideals set
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CH 2.4 Modern Economies Rise of Mixed Economies
Circular flow diagram of Mixed Economy Comparison of mixed economies of other nations Free Enterprise in the US
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Most economies today are a mix of the three mentioned for various reasons
Traditional - Little potential for growth or change Centrally Planned - Cumbersome decision making, too many limits on freedom
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Limits on Laissez Faire
Adam Smith acknowledged that there would have to be some sort of control by the Govt. National Defense, Roads and highways Public Parks, Libraries, Education, Health Care Property rights, enforcing contracts (patents), mass transit Domination of certain industries by one or few companies (Monopoly and Antitrust Laws) Where do we draw the line? Taxes for an army, education for everyone, unemployment, minimum wage?
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Circular Flow Diagram of a Mixed Economy
Govt needs supplies Govt owned factors Govt purchases JOBS $ $ FIRM H GOVT Govt takes $ For various reasons Taxes Taxes Physical Govt pays workers $ Circular Flow Diagram of a Mixed Economy
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Free enterprise - private ownership of capital goods
Investment decisions made privately Privatization – taking public goods and making them privately controlled Centrally Planned Free Market Iran N Korea Cuba China Russia Hong Kong Singapore USA Canada United Kingdom France Peru South Africa Botswana Greece CONTINUUM
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Govt Intervention Dominates
North Korea 95% of goods are produced in state owned factories Little imports allowed No production of goods/services by foreign companies allowed Lots of crime – Black markets and smuggling China 25%+ of businesses partially owned by individuals Currently in transition period to a market based economy Privatization of firms
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Market System Dominates
Hong Kong Govt does protect private property Wage and price controls Otherwise stays out of the market Few limits on foreign trade or foreign investment
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The US However… Free Enterprise
Govt keeps order, promotes general welfare High level of economic freedom People want more/less intervention all the time Low level of Govt regulation Protection of private property Trade retaliations and restrictions against other countries
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