Transcript Ch. 2: Economic Systems

Ch. 2: Economic Systems
Section 1: Answering the Three
Economics Questions
Economic Systems
• An economic system is the method a society uses to
produce and distribute goods and services.1
Three Questions
• Every economic system must ask the three
fundamental questions:
– What should be produced?
– How to produce?
– Who consumes what we produce?
What to produce?
• What goods and services should be produced
in our economic system?
– Due to scarcity, what will be prioritized?
How to produce?
• How should goods and services be produced?
– What energy should be used?
– Small businesses or large corporations?
For who?
• Who consumes the goods and services
produced?
– How are resources distributed?
Economic goals and values
• Systems make choices based on their
economic goals and values.
• What is most important?
– Efficiency
– Freedom
– Security and predictability
– Equity
– Growth and innovation
– Sustainability
Economic Efficiency
• Economic efficiency is making the most of
available resources
Economic Freedom
• Economic freedom values individual decision
making and freedom from government
intervention.
Economic Security and Predictability
• Economic security is the assurance that goods
and services will be available, payments will
be made, and safety nets are in place.
Economic Equity
• Economic equity values the fair distribution of wealth.
– Safety nets: government protections in place to aid
those in need
Gini Index
• 0 = complete financial equality, 1 = complete financial inequality
Economic growth and innovation
• Economic innovation leads to growth, which leads to a higher
standard of living.
– Standard of living: level of prosperity and comfort
Economic Sustainability
• Economic sustainability is the ability of an
economy and environment to survive.
Economic goals and values
• Systems make choices based on their
economic goals and values.
• What is most important?
– Efficiency
– Freedom
– Security and predictability
– Equity
– Growth and innovation
– Sustainability
Four Types of Economies
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Traditional Economies
Market Economies
Command Economies (Centrally Planned)
Mixed Economies
Traditional Economies
• Relies on custom, or ritual to make the three economic
decisions.
• Family and community centered.
Market Economies
• Economic decisions are made by many
individuals and based on exchange or trade.
• Also called free markets or capitalism
Command Economies
(centrally planned economies)
• Central government alone decides the key economic questions.
• Government acts as the central economic authority.
Mixed Economies
• Market-based economy with limited government involvement
in economic decision making.
Economic Continuum
• Most economies are not entirely market or
command, but mixed to varying degrees.
Command
(Centrally Planned)
Free Market
Economic Continuum
• Most economies are not entirely market or
command, but mixed to varying degrees.
Iran
Cuba
North Korea
Command
(Centrally Planned)
Mexico
China
Russia
France
South Africa
Poland
Japan
United Kingdom
Canada
United States
Hong Kong
Singapore
Free Market
Section 2: The Free Market
• A market is any arrangement that allows
buyers and sellers to exchange things.
Specialization
• Specialization allows for individuals or businesses to
concentrate on a limited good or service.
• Markets allow for the exchange of these goods or services.
Firms and Households
• Firms (businesses) and households (a person or
group of people living together) are the primary
players and decision makers in a free market.
Profit
• Profit, the financial gain made in transaction,
is the goal of the free market.
Adam Smith: Free Market Philosopher
• Adam Smith wrote The Wealth
of Nations in 1776.
• Known as the father of
capitalist (market) theory
• Proposed that self-interest
created balance in economics
– Beehive metaphor
Incentives
• An incentive is anything that encourages people to behave in
certain ways.
• Smith observed that people respond predictably to positive
and negative incentives (ex. Low or high prices).
– Interest rates
Competition
• Competition: the struggle between producers for the business
of consumers.
• Competition is the driving force of capitalism, or free markets.
• Competition lowers prices and improves the quality of goods
and services.
The Invisible Hand
• Self-interest and competition naturally regulate
markets.
• Supply and demand create accurate pricing.
• Adam Smith called this the “invisible hand of the
marketplace”
Consumer Sovereignty
• In free markets, consumers are king.
• Through their demands, consumers determine what is
produced and how much they will pay for it.
Circular Flow of Market Economy
• Consumers and producers continually trade
goods and services for labor and capital.
Goods and Services
Money
Households
Firms
Money
Labor
Free Market Goals
• Free Market systems meet some economic
goals, but no all.
• What is most important?
– Efficiency
– Freedom
– Security and predictability
– Equity
– Growth and innovation
– Sustainability
Section 3: Command Economies
(Centrally Planned)
• In a centrally planned economy, the government
answers the key economic questions.
Communism & Socialism
• Socialism: a philosophy believing
that democratic means should
be used to evenly distribute
wealth.
• Communism: a centrally planned
political/economic system
controlled by an authoritarian
government.
Karl Marx: The Communist Manifesto
• Karl Marx believed the widening gap between rich
and poor would lead to an overthrow of the
establishment and a new system of shared wealth.
• Government would fade away in utopian society.
Former Soviet Union
• Vladimir Lenin led a communist overthrow of the
Russian Czar.
• Communist party began centrally planning the Soviet
economy.
Soviet Agriculture
• The government created large state-owned farms.
• Collectives were state farms leased to peasant farmers who
were required to produce for the government.
• Failure: millions starved
Soviet Industry
• Factories and industry also became state-owned.
• Military industry was prioritized.
• Opportunity cost was innovative, high-quality consumer goods.
China: Great Leap Forward
• China’s Great Leap Forward was a similar attempt
at government control of agriculture and industry.
• Again, millions starved
Soviet Individuals:
Workers and Consumers
• Due to government planning, individuals lacked
motivation and incentives.
• Consumer goods and opportunities were limited.
Command Economy Goals
• Command systems intend to create equity, but
lack other economic goals.
• What is most important?
– Efficiency
– Freedom
– Security and predictability
– Equity
– Growth and innovation
– Sustainability
Communism & Socialism
• Socialism: a philosophy believing that democratic
means should be used to evenly distribute wealth.
• Communism: a centrally planned political/economic
system controlled by an authoritarian government.
Section 4: Modern Mixed Economies
• Nearly all economies today are a mixture of
market and command economies.
Laissez Faire
• Laissez Faire (french): let it be
• Means markets should not be
interfered by the government.
• Adam Smith and others
believed markets should be
largely unregulated and
unrestricted.
Limits to Laissez Faire
With no government intervention in economies,
what goods or services might not be adequately
addressed?
Limits to Laissez Faire
• Some needs fall to the government to provide,
because no private group would.
– Roads & Highways
– Public Transportation
– Parks
– Education
– Healthcare?
Limits to Laissez Faire
• Governments also regulate and facilitate markets.
• Without government, monopolies could develop
which restrict free trade.
Industrial Robber Barons
• With limited government regulation in 19th century
markets, monopolies developed.
• Monopolies eliminate competition, the foundation of
free markets.
Circular Flow of Mixed Economy
• Government is added into market flow
Goods and Services
Money
Households
Taxes/Spending
Government
Money
Labor
Taxes/Spending
Firms
Economic Continuum
• Most economies are not entirely market or
command, but mixed to varying degrees.
Iran
Cuba
North Korea
Command
(Centrally Planned)
Mexico
China
Russia
France
South Africa
Poland
Japan
United Kingdom
Canada
United States
Hong Kong
Singapore
Free Market
Example: Sweden
• The Swedish government offers extensive services…
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450 days of paid parental leave
Free healthcare (braces, pt, etc.)
Free college
Employers are required to give a minimum of 30 days (6 weeks)
paid vacation.
– Eric’s Story
• But, Swedes pay 56 percent of their gross domestic
product in taxes (Americans pay 32 percent).
Public Healthcare Debate
• Should healthcare be nationalized?
– Arguments for:
• Everyone covered (15% currently aren’t)
• Central, consistent system
• Cost (advocates argue nationalized care would cut costs)
– Arguments against:
• Compromised quality of care
• Cost (opponents argue nationalized care would increase
costs)