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HONORS ECONOMICS
CHAPTER 2: ECONOMIC SYSTEMS
CHAPTER 3: AMERICAN FREE ENTERPRISE
I.
Economic Systems
Definition: The way people and societies organize economic life to deal with scarcity and achieve
its economic goals.
Set of rules that govern what to produce, how to produce them, and for whom they are produced.
A.
Traditional Economies
1. Roles and economic decisions are defined by custom
a. repeat decisions made at an earlier time or by an earlier generation
2. Most evident in rural areas of the less developed countries of Asia and Africa
3. Growth slow
4. Advantages
a. everyone knows which roles to play
b. little uncertainty about what, how, and for whom to produce
5. Disadvantages
a. discouragement of new ideas
b. lower standard of living (subsistence)
B.
Command Economies
1. Largely an authority such as a feudal lord, dictator, or government agency makes decisions.
(Government decides what, how, and for whom
2. People must accept the decisions
3. Most evident in North Korea, Cuba, Vietnam, and China
4. Advantages
a. ability to drastically change direction in a relatively short time
b. little uncertainty for its citizens
5. Disadvantages
a. consumer needs may not be met
b. hard work not rewarded
c. large bureaucracy consumes resources
d. little flexibility to deal w/ day to day problems
e. individual initiative goes unrewarded
C.
Market Economies
1. Producers/Consumers determine what, how, and for whom to produce
2. Examples include the United States, Canada, Japan, South Korea, Singapore, and parts of
western Europe
3. Individuals own factors of production
4. System of decentralized decision making
a. all persons participate by registering their desires in the market
b. Market “adds up” these individual desires and creates aggregate forces called
Demand/Supply which determine prices
5. Key ingredients in a free enterprise economy
a. Buyers
b. Sellers
c. Profits
(1)
the profit motive is the force that drives sellers to produce what buyers
want at the lowest possible price
6. Advantages
a. ability to adjust to change
b. high degree of individual freedom
c. small degree of government involvement
d. ability to have a voice in the economy
e. variety of goods and services created
f. high degree of consumer satisfaction
7. Disadvantages
a. inability of the market to meet every person basic need
b. inadequate job of providing services such as justice, education, and health care
c. citizens face a high level of personal uncertainty and the prospect of economic failure
II.
Evaluating Economic Performance
A. Economic and Social Goals
1. Efficiency: wise use of resources so that people will be better off
2. Growth: expansion of the economy to produce more goods, services, and wealth
3. Stability (Price): price remains somewhat constant- inflation v. deflation
4. Security: those unable to care for themselves will be provided for
5. Equity: fair and just
6. Individual Freedom: freedom to make our own economic decisions
B.
III.
Trade – Offs Among Goals
1. When goals are at odds, people must compare costs to benefits before resolving the conflict.
Capitalism and Economic Freedom
A.
Characteristics of the American Economy
1. A pure market economic system has six major characteristics
a. little or no government control
b. freedom of enterprise
c. freedom of choice
d. private property
e. profit incentive
f. competition
2. Capitalism
a. Adam Smith – The Wealth of Nations (1776)
(1)
described Pure Capitalism
(2)
according to Smith the economy ran itself – government played a very
little part Laissez Faire
(3)
the “invisible hand” according to Smith is the belief that people acting in
their own self interest would do what was best not only for themselves but
also for the economy and society as a whole
b. Capitalism is based chiefly on private ownership of property. Most means of
production and distribution are privately owned and operated.
3. Freedom of Enterprise
a. a system in which individuals are free to own and control the factors of production
b. Pillars of a Free Enterprise: private property, price system, and competition
(1)
Private Property
(a)
Americans own property
(b)
Gives the owners of natural resources and capital the incentive to
put their assets to work
(2)
Price System
(a)
force that directs the economy
(b)
prices are the allocation mechanism
(c)
prices act as signals, flashing information to households,
producers, workers, savers, and investors to help them to decide
what are the most rational and profitable decisions
(d)
price system encourages sellers to produce goods and services at
the lowest possible price (lower prices increase the standard of
living)
(3)
Competition (source of efficiency)
(a)
rivalry among buyers and sellers
(b)
buyers compete by deciding whether to buy or not and how much
to pay
(c)
sellers compete by anticipating what buyers want and giving them
the most attractive deals in terms of price and quality
(d)
buyers get what they want at the best price and sellers are
rewarded for competent production (efficient way to allocate
resources)
4. Economic Incentives
a. factors that cause people to behave in certain ways as they strive to earn a living
b. Individual Self Interest
(1)
most important motivating force behind economic behavior
(2)
consumers allocate limited income to increase satisfaction
(3)
producers pushed by the profit motive produce goods/services efficiently
that consumers want to buy
(4)
workers sell labor where return in money and working conditions is
highest
(5)
savers search for the highest interest rates
c. Profits
(1)
(2)
what remains after the costs of production have been deducted from sales
profit motive (incentives) drives entrepreneurs to risk capital in business
ventures, improve products, reduce costs, and allow businesses to expand
5. Economic Rights
a. Legal equality: everyone has the same legal right to compete in the market place
B.
The Role of the Government in our Economy
1. Safeguards the market system (preserves competition)
a. Anti-Trust Laws
(1)
Sherman Act (1890)
(2)
Clayton Act (1914)
(3)
Federal Trade Commission (1914)
(4)
Celler Anti-merger Act (1950)
2. Government provides public goods and services
a. public good is a shared good or service for which it would be impractical for
consumers to pay individually and to exclude nonpayers
b. cost is critical to determine if something gets produced as a public good
(1) public if the benefit to each individual is less than the cost that each would
have to pay if it were provided privately
(2) public if the total benefits to society are greater than the total costs
c. Free-rider problem (associated with public goods)
(1) someone who would not choose to pay for a certain good or service but who
would get the benefits of it anyway if it were provided as a public good
3. Programs to prevent pollution and other harmful externalities
a. externality is an economic side effect of a good or service that generates benefits or
costs to someone other than the person deciding how much to produce or consume
(1) positive v. negative
4. Programs to assist those in need
a. welfare programs
5. Programs to help special groups
6. Promotes growth and stability
a. full employment, increases in GDP, and stability of prices
7. Provides incentives for innovation
a. patents and copyrights
8. Promoter of national goals
a. resulted in a mixed economy, or modified private enterprise economy