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“Introduction to Economic Systems”
Critical Questions
• What key economic questions must
every society answer?
• What basic economic goals do societies
have?
• What types of economic systems exist
today?
What is an economic system?
The method used by a
society to produce and
distribute goods and
services
The Three Questions that Determine
a Societies Economic System
Because ALL economic resources are scarce,
every society must answer three questions:
– What goods and services should be
produced?
• Guns or butter?
– How should these goods and services be
produced?
• What combination of factor resources
should we use?
– Who consumes these goods and
services?
• How will income be distributed?
Economic Goals
Societies answer the three economic questions based on their goals
and values.
Economic Goals
Economic Goals
Economic efficiency
Making the most of resources
Economic freedom
Freedom from government intervention in
the production and distribution of goods
and services
Economic security
and predictability
Assurance a safety net will protect
individuals in times of economic disaster
Economic equity
Fair distribution of wealth
Economic growth
and innovation
Other goals
Innovation leads to economic growth, and
economic growth leads to a higher
standard of living.
Environmental protection, variety
Four Economic Systems
An economic system is the method used by a society
to produce and distribute goods and services.
Traditional economies rely
on habit, custom, or ritual to
decide what to produce,
how to produce it, and to
whom to distribute it.
In a centrally planned
economy the central
government makes all
decisions about the
production and
consumption of goods and
services.
In a market economy
economic decisions are
made by individuals and
are based on exchange, or
trade.
Mixed economies are
systems that combine the
free market with limited
government intervention.
Simply Put:
Economic System
Who answers the 3 ?’s
•
•
•
•
 Custom
 Individuals
 Central Government
 Individuals with
some government
involvement
Traditional
Market
Centrally Planned
Mixed
Traditional System

Culture decides:
 what to produce
 how to produce it
 who consumes
 Often found in what you
might call “primitive societies”
 Agricultural and
hunting societies
ATTRIBUTES:
Little room for innovation or
change
Lack modern conveniences and
have low standard of living
Close knit communities with focus
on the family unit
The Free Market System (a.k.a. Capitalism)
Why do markets exist?
Markets exist because none of us produces
all the goods and services we require to
satisfy our needs and wants.
A market is an arrangement that allows
buyers and sellers to exchange goods and
services.
Specialization is the concentration of the
productive efforts of individuals and firms on a
limited number of activities.
Free Markets
Circular Flow Diagram of a Market Economy
• In a free market
economy, households
and business firms use
markets to exchange
money and
products.
Households
• Households
own the factors
of production
and consume goods and
services.
monetary flow
physical flow
Firms
physical flow
monetary flow
Adam Smith (1723-90)
• Scottish social philosopher and professor
that wrote one of the most influential books
on market economics.
• His book, “An Inquiry into the Nature and
Causes of the Wealth of Nations”, was
published in 1776. The book took 10 years
to write and consisted of 5 volumes.
• The book describes the way in which
markets function without government
intervention. A “laissez faire” approach.
Adam Smith and the Invisible Hand
• In every transaction, the buyer and seller
consider only their self-interest, or their own
personal gain. Self-interest is the motivating
force in the free market.
• Producers in a free market struggle for the
dollars of consumers. This is known as
competition, and is the regulating force of the
free market.
• The interaction of buyers and sellers, motivated
by self-interest and regulated by competition,
all happens without a central plan. This
phenomenon is called “the invisible hand of the
marketplace.”
Free Markets? Ask the Butcher
“It is not from the benevolence of the butcher, the
brewer, or the baker, that we can expect our
dinner, but from their regard to their own
interest.”
- Adam Smith (1723 -90)
Advantages of the
Economic Efficiency
Free Market
As a self-regulating
system, a free
market economy is
efficient.
Economic Growth
Because competition
encourages
innovation, free
markets encourage
growth.
Economic Freedom
Free market economies have
the highest degree of
economic freedom of any
economic system.
Additional Goals, i.e. variety
Free markets offer a wider
variety of goods and services
than any other economic
system.
Centrally Planned Economies
The government,or
central authority
controls the
economy.
Organization of Centrally Planned Economies
In a centrally planned economy, the government
owns both land and capital. The government
decides what to produce, how much to produce,
and how much to charge.
Socialism is a social
and political philosophy
based on the belief
that democratic means
should be used to
distribute wealth
evenly throughout a
society.
Communism is a political
system characterized by a
centrally planned economy
with all economic and
political power resting in the
hands of the government.
Communist governments are
authoritarian in nature.
• German philosopher
• Developed radical approach to understanding
and coping with the problems that occurred in
free market systems
• Published the Communist Manifesto in 1848
with close friend Frederick Engels.
• In his pamphlet he argued that history is a
series of class struggles between the rich
capitalists and the working class “proletariat”.
• He believed that eventually workers needed to
unite and revolt against the capitalists. This
revolution would then breed a classless society.
KARL MARX(1818-1883)
Frederick Engels
Karl Marx
Philosophy Becomes Reality
In 1917, the ideas proposed
by Marx would become a
reality.
The Bolshevik Revolution,
led by communist
Vladimir Lenin, would
result in a centrally
planned society.
The Soviet Experiment
• Factors of production were all controlled by the state.
• The best resources were allocated to the armed forces,
space program, and production of capital goods.
• Government committees decided the quantity, process
and distribution of all products.
• The government created large state-owned farms and
collectives to produce all agricultural products.
• There was little incentive to produce, and the Soviet
Union saw a decline in the production of agricultural
goods.
Problems in Centrally Planned Economies
• Poor-quality goods, shortages, and
diminished production
• Performance falls short of the set ideals
• Fail to meet consumer needs and wants
• Little individual incentives to work hard
• Lack of innovation
• Expensive and inflexible government
structure needed to manage the system
• Sacrifice of individual freedoms to pursue
societal goals
Cuba
Laos
North Korea
Vietnam
Declared
“Communist” States
China
Declared “Communist”
Countries in 1980
HAPPENED?
What
Mixed Economies
• It is doubtful that any
nation can exist
successfully under a pure
centrally planned economy or a
pure market economy.
• Most economies mix features of
both systems.
An economic system that permits the conduct of business with minimal
government intervention is called free enterprise. The degree of
government involvement in the economy varies among nations.
Nations are placed on a continuum (a range with no clear divisions) of
mixed economies. On one end are centrally planned economies and
on the opposite end are free markets economies.
Continuum of Mixed Economies
Centrally planned
Free market
Iran
North Korea
Cuba
South Africa
China
Russia
France
Botswana
Greece
United Kingdom
Canada
Peru
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
Hong Kong
Singapore
United States
Comparing Mixed Economies
Systems Graphic
• Side One- List and describe each of the four economic
systems. Provide an example for each system.
• Side Two- Visual representation of each system. This
visual representation should be creative and neatly
executed! It will be graded based on content AND
appearance!
THIS IS NOT AN EXAMPLE OF A COUNTRY, IT IS A
VISUAL REPRESENTATION OF THE CONCEPT
USE YOUR NOTES AND TEXTBOOK TO HELP
WITH THIS ASSIGNMENT!!
System Slogans
1. Create a “bumper sticker” for one of the four
economic systems.
2. Bumper sticker must be a visual
representation of the economic system. This
should be a visual of the IDEA!
3. Must have visual appeal and creativity.
4. Must be neat…take your time!
Chapter 3 and 13
American Free
Enterprise
Understanding America’s
Economic Structure
Tradition of Free Enterprise
The Economic Trade-off: Freedom vs. Protection
Traditionally Americans have favored economic freedom over
economic regulation.
While we value freedom, we still expect the government to protect
us from the problems that can exist in free markets.
The more freedom that Americans give up in the name of public
interest—the further we move away from the free market end of
the continuum.
All Americans act to decide when the benefits of government
protection outweigh the drawbacks to free enterprise.
Rights and Roles of the American Consumer
• Rights
• Property Rights
• Contracts
• Taxation
• Roles
• Consumer
• Voter
The Role of Government
1. Protect the Public Interest
2.Provide Information
3. Promote Growth and Stability
Key Indicators
The Financial System
Inflation
Employment
Gross Domestic Product
Gross Domestic Product
The main indicator used to determine overall
health of the economy is gross domestic
product (GDP) which is the dollar value of
all final goods and services produced within
a country’s borders in a given year.
This will allow them to better determine
upcoming business cycles to determine
prosperity, recession or depression.
Limitation of GDP
• Non-market activities
• Underground economy
• Quality of life
GDP vs. GNP
Annual income earned by
US owned firms and citizens.
Other
Indicators
2004
3.1
2005
2.7
2006
2.4
2007
2.3
United States GDP 2004-2007
Source: http://www.bea.gov/national/index.htm#gdp
Updated Information!!
2007 Q4
-0.2
2008 Q1
0.9
2008 Q2
2.8
2008 Q3
-0.5
United States GDP 2007-2008
Source: http://www.bea.gov/national/index.htm#gdp
Types of Unemployment
1.
2.
3.
4.
Frictional Unemployment- Occurs when people change jobs,
get laid off from their current jobs, take some time to find the
right job after they finish their schooling, or take time off from
working for a variety of other reasons
Structural Unemployment- Occurs when workers' skills do not
match the jobs that are available. Technological advances are
one cause of structural unemployment
Seasonal Unemployment- Occurs when industries slow or shut
down for a season or make seasonal shifts in their production
schedules
Cyclical Unemployment- Unemployment that rises during
economic downturns and falls when the economy improves
Unemployment Rates
•A nation’s unemployment rate is an
important indicator of the health of the
economy.
•The Bureau of Labor Statistics polls a sample
of the population to determine how many
people are employed and unemployed.
•The unemployment rate is the percentage of
the nation’s labor force that is unemployed.
Getting Everyone To Work!!!!
• Economists generally agree that in an economy
that is working properly, an unemployment
rate of around 4 to 6 percent is normal.
• Sometimes people are underemployed, that is
working a job for which they are overqualified, or working part-time when they
desire full-time work.
• Discouraged workers are people who want a
Other
job, but have given up looking for
one.
Indicators
Full employment is the level of employment reached
when there is no cyclical unemployment.
Going….UP!!!!!!!!!!
• Inflation is a general increase in
prices.
• Purchasing power, the ability to
purchase goods and services, is
decreased by rising prices.
To Market, To Market
A price index is a measurement that shows how the average
price of a standard group of goods changes over time.
• The consumer price index (CPI) is computed each month
by the Bureau of Labor Statistics.
• The CPI is determined by measuring the price of a
standard group of goods meant to represent the typical
“market basket” of an urban consumer.
What would it cost in 1925?
What is in the basket?
There are over two hundred categories of products that are
included in the basket. These categories fall under 8
major groups:
FOOD AND BEVERAGES
HOUSING
APPAREL
TRANSPORTATION
MEDICAL CARE
RECREATION
EDUCATION AND COMMUNICATION
OTHER GOODS AND SERVICES
Inflation Theory
• Quantity Theory
– Too much $ in the economy
• Demand-Pull
– Demand exceeds supply
• Cost-Push
– Increased input costs for the
supplier
Danger…Prices on the Rise
High inflation is a major economic problem, especially
when inflation rates change greatly from year to year.
The three main problems are:
–Reduced Purchasing Power
–Erosion of Interest Income
–Erosion of Wages/Income
The Financial System
• The United States financial system includes banks,
securities exchanges, pension funds, insurers, the
Federal Reserve and national regulators.
• These firms and institutions:
– Provide infrastructure for economic transactions
– Channel funds from savings to investment
– Control monetary policy
• A sound financial system is essential for
macroeconomic growth and financial stability.
Result of Instability in the Financial System
1.
2.
3.
4.
5.
Diminished monetary policy
Prolonged economic downturn
Capital flight
Costs of “rescue”
Impact global markets
Issue Focus:
The Poverty Problem
The Poverty Problem
Although the free market is the most
successful economic system at producing
wealth—distribution is HIGHLY uneven.
The poverty threshold is an income level
below what is needed to support families or
households. What is the current
threshold?!?!?!?!?!?!!??
POVERTY...THE FORGOTTEN STATE
What factors contribute to poverty?
Lack of jobs
Lack of educational opportunities
Changes in family structure
Economic shifts
Racial and gender discrimination
Culture of poverty
Who does the government provide
a safety net for?
Elderly
Disabled
Children
Poor
Welfare Programs
Welfare is a general term that refers to
government aid to the poor
1930’s- Under Roosevelt the government
began welfare programs to reduce the
impact of the Great Depression.
1960’s- Lyndon Johnson launched the
“War on Poverty”
1990’s- Clinton transformed welfare
program to Temporary Assistance to Needy
Families (TANF)
The Four Types of
Redistribution Programs
Cash Transfers
Direct payment of cash to
eligible people
EXAMPLES
•Temporary Assistance to Needy
Families (TANF)
•Social Security
•Unemployment Insurance
•Workers Compensation
In-Kind Benefits
Goods and services provided by the
government for free or reduced prices
EXAMPLES
• Food Stamps
• Legal Aid
• Subsidized Housing
Medical benefits
Health insurance is provided to those
that cannot provide it for themselves.
EXAMPLES
• Medicare for the elderly and disabled
• Medicaid for the poor
Education benefits
Federal, state, and local government all
provide money for the poor and
disabled to ensure all people receive
educational opportunities.
EXAMPLES
Head Start
Special Education Programs
Need-Based College Grants