2. 1 Economics Lecture 4 2007 Economics Dept Mr Lim Peng Yeow

3. 2 Self-Discovery Slides Types of Economic Systems What is Free Enterprise (market system)? How does it work?

4. 3 Types of Economic Systems Government Market forces Centrally Planned Free Enterprise Mixed

5. 4 ECONOMIC SYSTEMS: free-market economy Free enterprise / free-market economy - an economy where all economic decisions are taken by individual households and firms and with no government intervention

6. 5 ECONOMIC SYSTEMS: free-market economy Main features of the free enterprise  Private ownership of all resources  Limited ownership by government  Freedom of choice – consumer sovereignty consumers’ willingness and ability to pay  high prices  resources allocated into the production of this good

7. 6  Freedom of choice – free enterprise for producers governed by profit motive  producers can sell what they want to – free mobility of resources governed by returns  factor owners are free to sell their factors anywhere ECONOMIC SYSTEMS: free-market economy

8. 7 Economic Freedom absence of obstacles to effective choices Freedom of Consumer Choice Freedom of Enterprise acquire any resource use any technology produce any product charge at any price invest their profits buy any product accept any job quit any job Households Firms Consumers Workers Freedom of Choice of Jobs

9. 8  Motivated by self interest – consumers - maximum satisfaction – producers - maximum profits – factor owners - maximum returns (rent, wages, interest) ECONOMIC SYSTEMS: free-market economy

10. 9  Existence of competition – large numbers of buyers and sellers – free flow of information – little or no advertising – free entry and exit of firms ECONOMIC SYSTEMS: free-market economy

11. 10 Meaning of price mechanism  the system in a market economy whereby changes in price in response to changes in demand and supply have the effect of making demand equal to supply ECONOMIC SYSTEMS: free-market economy

12. 11 Price mechanism  determines the allocation of resources within the economy  works through interaction of demand & supply and price signals  prices measure the value of goods and services measured in terms of standard monetary unit ECONOMIC SYSTEMS: free-market economy

13. 12 PRICE MECHANISM Prices on Factor Mkts (wages, rents, interest) Prices on Factor Mkts (wages, rents, interest) HouseholdsHouseholds FirmsFirms Prices on Goods Mkts Demand g & s Supply fop WHAT?HOW? FOR WHOM? WHAT?HOW? Supply g & s Demand fop Factor income Consumers’ expdt Firms’ expdt Firms’ rev.

14. 13 What to produce? Consumer sovereignty: Consumers, through their money “ votes ”, dictate what goods should be produced. Demand for cars  Price of cars  Profits of car manufacturers  Firms will want to supply more cars Firms pay more to attract workers & other fops Workers & other fops move away from other industries into the auto industry

15. 14 How to produce? Firms will choose the method of production which minimises the cost of production. Hence, if the price of one resource is high relative to its productivity, producers will try to substitute a cheaper input for a more expensive one.

16. 15 For whom to produce? Since the demand for a good must be effective, i.e. backed by the ability to pay, goods will be produced for those who have the purchasing power (higher income).

17. 16 Advantages of a free-market economy  functions automatically - no need for costly and complex bureaucracies to co-ordinate economic decisions  highly competitive market - more responsive to consumer wishes  efficient use of resources (what, how, how much and for whom to produce) ECONOMIC SYSTEMS: free-market economy

18. 17 Problems of a free-market economy  competition between firms is often limited - a few large firms  lack of competition and high profits - little incentive for firms to be efficient  unequal distribution of power and property  ignore external costs of production  no production of public goods ECONOMIC SYSTEMS: free-market economy

19. 18 Problems of a free-market economy  macroeconomic instability - periods of recession with high unemployment and falling output, and other periods of rising prices  by rewarding self-interest - may encourage selfishness, greed, materialism and acquisition of power ECONOMIC SYSTEMS: free-market economy

20. 19 Features of the 3 Economic Systems Free Enterprise System Centrally Planned Economy Mixed Economy Alternative Names Laissez- faire Capitalist system Command economy Planned economy

21. 20 Features of the 3 Economic Systems Free Enterprise System Centrally Planned Economy Mixed Economy Examples Hong Kong North Korea Cuba US UK Singapore

22. 21 Features of the 3 Economic Systems Free Enterprise System Centrally Planned Economy Mixed Economy Features 1. Ownership of Resources / Factors of Production (fops) Private ownership (i.e. by individual households & firms) of almost all fop Public ownership (i.e. by the state) of almost all fop Public & private ownership

23. 22 Features of the 3 Economic Systems Free Enterprise System Centrally Planned Economy Mixed Economy Price mechanismPrice mechanism Govt directivesGovt directives Feature 2. How economic decisions are made Price mechanism & govt directives

24. 23 Features of the 3 Economic Systems Free Enterprise System Centrally Planned Economy Mixed Economy Self- interestSelf- interest For the common good of the nation Feature 3. Dominating motive Self- interest & common good