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Chapter 2
Economic Systems
A. Economy or Economic System
– An organized way of providing for the wants
and needs of a society.
• Three Types of Pure Economic
2. Command
3. Market
B. Traditional Economy
• Based on custom and
• answers to the 3
economic questions are
found in the past
• Children often carry on
roles of their parents as
hunters or farmers
• Drawbacks: new ideas
are discouraged and
often punished
• Ex. Canadian Inuits
C. Command Economy
• Government officials answer
economic questions. Central
planners decide who will
receive products and what
will be produced.
Strengths: can easily change
economic direction
Weaknesses: they do not always
meet the needs of individuals,
there is little incentive for
individuals to work hard, large
bureaucracies often are slow
making decisions, are not flexible
enough to deal with day to day
Ex. North Korea, Cuba, and the People’s
Republic of China.
D. Market Economy
• Individuals answer
the 3 economic
• Government has no
say. Factors of
(resources) are
owned by individuals
• People can buy, sell,
or produce anything
they want
E. Mixed economies- combine elements of
traditional, market, & command economic
• Authoritarian socialism or
communism- closest to command
– the government owns or directs
nearly all factors of production
• Capitalism- economies closest to
• Democratic Socialism- between
authoritarian socialism and
– Gov’t owns some factors of prod.
usually key industries like
utilities, telephone, etc. Leaders
are elected by the people.
(Sweden, Poland, France.)
F. Capitalism
Private individuals own
resources & choose
• Produces more
how they are used.
w/available resources
– Gov’t has limited
than others
economic power, acts
• Provide equality of
only to prevent fraud
opportunity b/c of strict
or others from using
property protection rights
force, and to protect
Drawbacks: does not
distribute wealth equally.
Despite basic fairness
there will always be
producers and
consumers are
– (Canada, Mexico, Japan,
G. Adam Smith- Philosopher &
economist who explained the
process of market regulation.
• when the government is not
involved in the economy that the
market is purely driven by selfinterest.
• self-interest acts as an “invisible
hand” that leads people to do
what is best for society
• Incentives- can be positive or
negative- encourage people to
behave in a particular way
How does the Free Enterprise System Work?
5 features of the U.S. Free Enterprise System:
Individuals can:
1. Own private property and enter into contracts
A. Private Property: goods that are owned by
individuals and businesses rather than by the
B. Contracts- agreements between individuals to
buy and sell goods and services- contracts can be
written or oral
2. Make individual choices- laborers, producers
and consumers can decide how to satisfy their
needs and wants
3.Engage in economic competition
– Competition- the economic rivalry that exists
between businesses selling the same product. (It
encourages producers to make and improve
products and lower costs.)
4.Make decisions based on self-interest- profit motive
– Profit- the extent to which persons or
organizations are better off at the end of a period
then they were at the beginning
– Profit motive- the driving force that encourages
people and organizations to improve their material
well being
5. Participate in the economy with limited government
involvement and regulation
How would a traditional system, a command system and a
market system differ in the way they would emphasize or
not emphasize the following broad social goals of society.
1. Economic
2. Economic
3. Economic
4. Economic
5. Environmental
• Circular Flow Model
• What economic concept does the circular
flow model show?
1. Household- individual or family unit
that occupy a single home & have
common living expenses.
a. What do they exchange with businesses?
they receive income in exchange for labor
in the form of a wage.
• As consumers, households make
expenditures to businesses for which they
receive goods and services.
b.What do they pay to the government?
households pay taxes. 1st Period
c.What do they get from the government?
they receive public goods and services, low
income households receive transfer
• Transfer payments redistribute wealth
through programs like welfare.
2. Businesses/Firms-individuals work
together to produce a good or service.
a. What do businesses exchange with
households? From households-get labor for
which they pay wages- are consumers &
b.What do businesses exchange with the
government? pay taxes and get subsidies
c. What is a subsidy? a payment to a business
firm that cannot profit on its own. May be given
b/c the firm is vital to nat’l security, or significant
for the country, or essential for economic
3. Government- limited role in the US.
a.How does the government get income? Takes
in money for taxes (income, property, user fees,
tariffs, sales taxes)
b.What are government expenditures? Transfer
payments and subsidies and providing public
goods and services.
c.What is a public good?
It is not able to be depleted and cannot be easily
denied to people b/c of non-payment like
Markets in the Circular Flow Model
• What is the factors (Resource) market?
• The market for resources like land, labor,
capital to be used in production.
• What is the products market?
• Where goods are sold for consumption by
1. Distinguish between product and factor
2. Using the information you have learned,
write a paragraph on "you as a labor unit."
What do you have to offer to the factor
market that will help you get what you
want out of life? How, specifically, can you
increase your value in the factor market
1) Businesses provide the government with
A. taxes and goods and services.
B. taxes and labor.
C. services and income
2) Businesses receive _____ and ____ from the
A. taxes and goods and services
B. services and payments
C. taxes and labor
3) Households provide businesses with
A. labor and payments.
B. services and income.
C. taxes and goods and services.
4) Businesses provide households with
A. taxes and income.
B. labor and payments.
C. income and goods and services
• Using the information learned so far, write
a paragraph on "you as a labor unit." What
do you have to offer to the factor market
that will help you get what you want out of
life? How, specifically, can you increase
your value in the factor market?
2.3 The U.S. Economy at
Should the U.S. government
provide health-care coverage to all
U.S. citizens? Why or why not?
What are some of the benefits and
trade-offs of the U.S. government
providing health coverage to all
U.S. Economic Goals
1. Freedom
2. Efficiency- making the best use of scarce
3. Equity- policymakers try to ensure that all
members of society share in cost and
benefits of the free-enterprise system
4.Security- nation tries to protect members
from anything that might harm their
economic well being such as poverty,
business and bank failures, or medical
5. Stability: has two main goals:
• Full employment- lowest possible level of
unemployment in the economy
• Price stability- when the overall price of goods and
services available in the economy is relatively
constant (this refers to the prices of all goods taken
together, not of any one product)
6. Growth- efforts to increase the amount of goods
and services produced by each worker in the
economy. (If production per worker decreases then
there will be a decline in the nation’s standard of
living. )
• Standard of living- measures people’s economic
well being- is measured by how much the average
person in a country is able to consume in a year.