Download Chapter two econ

Economic Systems
Chapter two
AVID 2/9
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2.1 Answering the 3 Economic
Questions
 An economic system is the method used by a society to
produce and distribute goods and services.
 Different systems have been developed to resolve scarcity.
 Which system is chosen for a country often reflects it’s values
and goals.
Three key Economic Questions
 1. What goods and services should be produced?
 2. How should these goods and services be produced?
 3. Who consumes these goods and services?
 Since economic resources are limited, every society must
answer each question.
What to produce?
 Countries need to decide how much of their resources
should be devoted to defense, education, public health or
consumer goods.
 Then they need to figure out which consumer goods to
produce
How should things be produced?
 Should we produce food on large corporate farms or on
small family ones?
 Should we educate our youth in small (20:1) classrooms or
larger (40:1) ones?
 Basically, a country needs to examine all the available factors
of production (land, labor and capital) and then figure what
will be used for what.
Who consumes?
 Americans want choices
 Recently the top 25 manufacturers have launched on average
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of 13 new products a day.
Retail stores offer about 30,000 items where in the past they
offered about 3,000.
Despite large outputs ,quantities are not unlimited.
The abundance of items of available gets divied up differently.
EX: some can afford a new luxury car and others only a bus
pass.
EX: some can go to a concert and others have to stay home
 Who gets what is often decided on how a society distributes
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their income.
Factor payments are the income that people receive when
they supply a factor of production.
How much should a plot of land be worth?
How much should we pay a teacher vs. a doctor?
Who gets what varies nation to nation based on the values
and goals of the nation
Econ Goals and Societal Values
 Countries are always looking to use resources efficiently
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(why make cds when people prefer to download music?)
Most people want to make their own economic choices
Would you like to see laws passed that would govern what you can
and cannot buy or setting what your maxmium wage would be?
People also want economic security and predictability
Ideally, an economic system will reassure people that goods
and services will be available to them when they need them
and that they will be paid on time.
Begin on Tues
 Many people want the security of knowing that if they lose
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their job that there will be unemployment insurance or that
their grandparents will be guaranteed a basic living wage.
Many people want a “safety net”
Economic equity also needs to be figured out
What constitutes someone’s “fair share”?
Should everyone get the same amount or should one’s
consumption depend on how much one produce’s?
How much should society provide to those who are unable or
unwilling to provide?
 It is essential that a country’s standard of living improve to
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ensure economic prosperity.
This is especially true if a country’s population is growing.
Innovation is very important.
EX: Improved technology will increase productivity + create
new jobs.
In addition, societies may to want to protect it’s environment
or give universal health care amongst other things that will
involve economic decision making
Economies and Values
 There are 4 different economic systems and each respond to
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the three essential questions differently
A. Traditional economy – relies on habit, custom or ritual in
making the decision of what to produce, how to produce and
how to distribute it
Work tends to be divided up along gender lines
Society tends to be small and take care of all in the group and
not just the individual
Often have little mechanisms in place to deal with economic
disasters
Tend to move slowly in adopting new practices
 B. Market economies – economic decisions are made by
individuals
 They decide what gets made and the goods are used
 Also known as a capitalist state
 C. Centrally planned economies – the government decides
all the major questions
 D.
 Mixed economies are market based economies with a limited
governmental role.
2.2 The Free Market
 A market is an arrangement that allows buyers and sellers to
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exchange items
They exist because few people (if any) are self sufficient.
Instead each person produces at least one good or service and
thus their engage in task specialization.
Economic systems that are based on voluntary exchanges in
the market are known “free market” countries
Households and firms are major players
Households own the factors of production (land, labor and
capital) and they are consumers of goods/services
 A firm (or business) is an organization that is made to use
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resources and produce a product
They transform “inputs” or factors of production to “outputs”
or products
Firms work to make profit (a financial gain)
Competition and self interest will keep markets functioning
Adam Smith wrote The Wealth of Nations and his theory was
an economy is made up of countless individual transactions.
In each transaction, the buyer and seller consider their own
self interest
 Consumers are always looking for the lowest prices
 Adam Smith also observed that people respond predictably to
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both positive and negative incentives
They respond positively to lower prices and vice versa
Firms seek to make greater profits by increasing sales and so
if stripped shirts become popular one firm (and many others)
will produce what is popular
They will have to watch each other’s prices too in order to
gain the most customers
Competition tends to moderate firms want to raise prices
 Self interest and competition often work as an “invisible hand” in
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the marketplace
The free market has many advantages:
1. Economic efficiency – producers only make want people want
and at prices they are willing to pay
2. Economic freedom – workers can work where they want, firms
can produce what they want, consumers can consume what they
want
3. Economic growth – competition encourages innovation, firms
always want to become more profitable by coming up with new
products or improving old ones
4. Additional goals – free market systems offer a wider variety of
items and so consumer sovereignty is very high
2.3 Centrally Planned Economies
 Centrally planned economies oppose private property, free
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market pricing , competition and consumer choice
The central government answers the key economic questions
of production and consumption
It collects info and then tells each firm what and how much
to produce
They own the land, capital and control the labor (set wage
prices and control where individuals work)
People are told what to plant and how much
Factories are told what to produce and how much
 There is no consumer voice in production and distribution
 No consumer sovereignty
 Socialist and Communist nations are most associated with
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this type of economy
Socialism is based on the belief society should distribute the
wealth evenly throughout society.
Real equality can only exist with economic equality
They are democratic nations with a lot of central planning (so
the government is much more powerful)
The government owns major industries (like ultities,
transportation and media)
 Communism is characterized by a centrally planned economy
with all economic and political power resting in the hands of
a central government
 They believe that a socialist society can only be achieved by a
violent revolution
 Most nations are authoritarian
A closer look at the Soviet Union
 Two revolutions in 1917
 In 1920s, the Soviet planners were most concerned with
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building national power and prestige within the international
community
Allocated best of everything into the armed forces, space
program and production of farm equipment and factories
Agriculture was produced on state run collectives
Workers were guaranteed a job and income and the
government in turn would get their quota of goods met
Under system there was no incentive to produce more or
better crops
 Consumer goods weren’t a priority + they were cheaply
made
 Good materials would not be allocated to them + since
factories got paid for meeting their quota and not for the
quality of their product….there was no incentive for doing a
great job
 Since consumer goods were in such high demand…there
were often long lines to wait for essentials or luxuries
 Housing shortages were very common and thus many people
lived very cramped apartments
Disadvantages
 Centrally planned economies can be used to jumpstart an
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industry and provided secure jobs (not a disadvantage)
But typically production almost always fall short
Consumers do not get their wants and needs satsified
Innovation is not encouraged
Hard work is not rewarded
Decisions involve many government offices and so often
become overly-complicated
Most have failed
2.4 Modern Economies
 100% free market or centrally planned economies are not
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seen in today’s modern world
Centrally planned economies are cumbersome and do not
meet consumer needs
Traditional economies have very little for growth
Free markets also have their share of issues
Adam Smith believed that left to its own devices , the free
market system would provide the greatest benefit for
consumers and raise the standard of living.
He preached laissez faire (govt should not intervene in the
marketplace)
 However, even Smith acknowledged the need for a limited
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degree of government intervention in the economy
Today modern society demands more government
intervention because all needs are difficult to satsify with just
the market alone
In many nations, education, health care and public
transportation projects are funded solely by the government
to ensure access for all
Most nations protect property rights and enforce contracts
There would little reason to innovate and invest with out
these protections
 At times nations need to mandate (often via taxes) things in
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order to meet the nation’s goals
Ex: pay taxes to maintain a strong national defense
Ex: pay taxes to give people who lost their job in a weak
economy unemployment
Ex: pay taxes to maintain schools
Etc.
 The government (like businesses ) also purchases land, labor
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and capital from households in the factor market
In the early 2000s the US employed 2.8 million people and
paid out $9.7 billion for their labor
Governments also purchase goods and services in the
product market (they office supplies, computers, etc.)
Again most nations are mixed economies and today many
nations that used be more centrally planned (like China) are
going through a transition period
Today they are privatizing many state own industries and
allowing more competition
 In the US our government intervenes to keep order, provide
vital services and to promote the general welfare
 Our govt does regulate the economy (protects certain US
made products, mandates a min wage, requires health care in
large companies)
 But it still allows foreign investments and free trade with
many nations