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Economic Systems 3 Basic Economic Questions What to Produce? A society cannot have everything its people want, so it must make decision 3 Basic Economic Questions How to Produce? Should it use more labor intensive or capital intensive production processes? Often determines efficiency 3 Basic Economic Questions For Whom to Produce? How are the resources distributed? Soviet citizens lined up for free bread (left) vs. bread aisle at American grocery store where prices are charged (right.) Social Goals Economic Freedom Individuals making their own decisions, pursuing own desires Economic Equity “Fairness” in the marketplace Social Goals Economic growth Long-term increase in quantity available to individuals Economic security Protection against economic risks such as inflation, unemployment, poverty Social Goals Economic efficiency Using least costly methods, most productive use of resources Environmental Quality Concern for environment and natural resources Social Goals When goals conflict, trade-offs must be made Economic System Structures, methods, and principles on how a society will use its scarce resources to produce and distribute goods and services Traditional Economic decisions based on: Ritual Habit Custom Traditional Individuals’ economic decisions Not made freely Defined by customs of elders and ancestors Traditional WHAT TO PRODUCE: One’s job may be based primarily on what ancestors or parents did Traditional HOW to produce: Same way as previous generations FOR WHOM: Depends on the tribe/society African Mbuti tribe Traditional Examples: African Mbuti tribe Australian Aborigines Indigenous peoples Canadian Inuits Australian Aborigines Traditional Economy Example Inuits Fish and hunt in harsh climate Spoils of hunt shared with the tribe Cut into equal parts Hunter responsible got first choice, respect of the community But not the entire kill Traditional Disadvantages: Discourages new ideas Strict rules punish those who act differently Leads to little progress Isolated Peruvian Mashco-Piro Indians Traditional Disadvantages: Without progress, standard of living decreases relative to societies that value behaviors that lead to progress Traditional Economic Example in the U.S. Native American reservations Operates outside the American free market system – Among the poorest sector of American society – Today, many tribes that live on designated reservations are primarily reliant upon U.S. government assistance Traditional “Any man who thinks he can be happy and prosperous by letting the government take care of him better take a closer look at the American Indian.” Henry Ford Centrally Planned Economy AKA – Command Economy Government bureaucracy decides: What to produce How to produce it For whom to produce Centrally Planned Economies Disadvantages: Economically Inefficient Lacks price signals to indicate changing economic conditions Lacks flexibility to quickly adjust to consumer demands Centrally Planned Economies Disadvantages: Economically Unfree Individual rights sacrificed to “greater good” Tens of millions executed as political prisoners Millions more starved to death due to government resource mismanagement Centrally Planned Economies Mao Zedong of China Worked, starved, or beat to death approximately 45 million from 19581962. Called the “Great Leap Forward” Communism Centrally planned economic system Single-party government Near-complete government control of political and economic decisions Examples: Soviet Union North Korea Cuba Communism Government owns all resources and means of production Concept of private property considered immoral Socialism Centrally planned economic system Democratic control of government and political institutions Multiple political parties seek election to office Socialist president Francois Hollande of France Socialism • Individuals usually have more economic freedom than in a communist economy but much less than under a capitalist economy Examples: Venezuela France Former socialist president, the late Hugo Chavez of Venezuela Authoritarianism Limit individual freedoms and require strict obedience All communist countries have been authoritarian, but not all authoritarian countries are communist All deprive citizens of political control Some take a hands-off approach to the economy Chile under Pinochet Former Chilean leader Agosto Pinochet overthrew democratically-elected socialist Salvador Allende and transformed its economy into a prosperous market economy. Karl Marx (1818-1883) German command economic philosopher Marxism Term for his collective thoughts on economic philosophy and society Said human societies advance through class struggle Conflict between ownership class that controls production and a laboring class that creates production Karl Marx (1818-1883) Advocated for working classes to carry out an organized revolution to end capitalism and bring about socio-economic change. A combination of social (status) and economic (wealth) factors Karl Marx (1818-1883) Economic thinker behind the Russian Revolution Bolsheviks over threw the Czars, creating the communist Soviet Union Books: Communist Manifesto Das Kapital Karl Marx (1818-1883) Advocated for communism (in which people had no say in government) until it was universally accepted Otherwise the rich (“bourgeoisie”) would undermine it Then socialism Karl Marx (1818-1883) Famous Quotes “From each according to his abilities, to each according to his needs.” Karl Marx (1818-1883) Famous Quotes: “The production of too many useful things results in too many useless people.” Karl Marx (1818-1883) Famous quotes: “There is only one way to kill capitalism – by taxes, taxes, and more taxes.” John Maynard Keynes (1883-1946) British founder of modern macroeconomics Keynesianism School of thought based upon his ideas Major Book: The General Theory of Employment, Interest, and Money John Maynard Keynes (1883-1946) Saw increasing a democratic government’s control of economy as a solution to rising tide of authoritarianism in early to mid 1900s. Communist Soviet Union (Lenin & Stalin) Nazi Germany (Hitler) Fascist Italy (Mussolini) John Maynard Keynes (1883-1946) Thought state intervention was necessary to moderate “boom and bust” cycles of economic activity Governments should “spend against the wind” (spend in bad times, save in good times) John Maynard Keynes (1883-1946) Advocated using government spending policies and manipulating the money supply to reduce effects of recessions and depressions Tolerate inflation to drive down unemployment John Maynard Keynes (1883-1946) Downplayed criticisms of the long-term effects of his policies “In the long run, we’re all dead.” Market Economy Most resources owned by private citizens Citizens own businesses, keep earned profits Market Economy Private individuals, without government interference, decide: What to make How to make it For whom to make it Price system Those willing and able to buy Voluntary Exchange Buyers and sellers freely and willingly engaging in market transactions Only happens if both are better off Voluntary Exchange Fundamental assumption of market economics Market economic theories assume mutual benefit Command economic theories assume exploitation Capitalism Market economic system Features: Capital accumulation Investible money and other things of value Competitive markets Wage labor Workers selling labor to employer under a formal or informal employment contract Adam Smith (1723-1790) Scottish market economic philosopher Famous book: An Inquiry into the Nature and Causes of the Wealth of Nations Adam Smith (1723-1790) The invisible hand of the market Describes selfregulating behavior of the market Markets automatically channel selfinterest toward socially desirable ends Adam Smith (1723-1790) Invisible hand of the market Example: AT&T wants to make $ People want to communicate AT&T provides communication services People give AT&T $ If AT&T is corrupt, unethical, provides bad service, or does anything else bad then customers will substitute towards competitors (Verizon, Sprint) Competitive pressure makes AT&T behave Frederic Bastiat (1801-1850) French market economic philosopher Developed the concept of opportunity cost Said sole legitimate government use of force was to defend an individual’s life, liberty, and property Frederic Bastiat (1801-1850) If government interferes in the economy for any other reason it is “legalizing plunder” Stealing from some on behalf of others Bank and automotive bailouts of 2008/2009 examples of rich using gov’t to plunder the poor Welfare example of poor using gov’t to plunder the rich Frederic Bastiat (1801-1850) Encourages other groups to organize to elect politicians to enact laws to help them plunder others Therefore government should not take from anyone to give to anyone Stop plundering for anyone Frederic Bastiat (1801-1850) Supported voluntary charity but opposed government forcing people to be charitable Is “forced charity” even charity? Famous book: The Law Frederic Bastiat (1801-1850) Famous quote: “The state is that great fiction by which everyone tries to live at the expense of everyone else.” State = government Friedrich von Hayek (1899-1992) Austrian market economist Keynes’ contemporary and intellectual rival Said eliminating inflation is the only goal of monetary policy Keynes approved tolerating moderate inflation to combat unemployment Friedrich von Hayek (1899-1992) Described how changing prices communicate information, allowing people to coordinate plans If the price of wood goes up, people may start using plastic mechanical pencils Spontaneous order Friedrich von Hayek (1899-1992) Valued individual political and economic freedom over all else Rejected Keynes’ compromise of economic freedom in order to preserve political freedom In Chile, preferred authoritarian dictator Augusto Pinochet over democratically-elected Socialist president Salvador Allende because people had more freedom under Pinochet. Friedrich von Hayek (1899-1992) Said socialism required central economic planning which inevitably leads to totalitarianism Loss of political freedom as well as economic freedom Friedrich von Hayek (1899-1992) Major book: The Road to Serfdom Milton Friedman (1912-2006) American market economist University of Chicago professor Proved that increasing the money supply faster than the economy was growing is the only factor that causes inflation Rise in prices caused by money’s loss of value Milton Friedman (1912-2006) Accurately predicted that Keynesian policy tolerating moderate to high inflation to fight unemployment would eventually lead to high levels of both inflation and unemployment Stagflation Milton Friedman (1912-2006) Group of Chilean students of his put together an economic program implemented by General Augusto Pinochet that transformed Chile from a poor country into the only developed (wealthy) economy in Latin America “The Chicago Boys” Milton Friedman (1912-2006) Famous Quotes: “There’s no such thing as a free lunch.” Milton Friedman (1912-2006) Famous Quotes: “Underlying most arguments against the free market is a lack of belief in freedom itself.” Left-Right Economic Spectrum The more command features an economy has, the more it is considered to be to the “left.” The more market features an economy has, the more it is considered to be to the “right.” Mixed Economy Share attributes of command and market economies State Capitalism Mixed economic system Combines capitalist wage and pricing mechanisms with state ownership Private ownership of means of production (natural & capital resources) allowed, but under tight government control State Capitalism Critics call it “venture socialism” Venture capital = financial capital provided in early development of startup companies with high growth potential State Capitalism Examples: China Russia Brazil United States taking controlling stake in GM in the auto bailout? Price Floor A price control or limit on how low a price can be charged for a product, usually imposed by the government Usually produces surpluses. Price Ceiling A price control or limit on how high a price can be charged for a product, usually imposed by the government Usually produces shortages.