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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.
Comparing Economic Systems
Economic System
Who answers the 3 ?’s
•
•
•
•
•
•
•
•
Traditional
Market
Centrally Planned
Mixed
Custom
Individuals
Central Government
Individuals with some
government
involvement
Traditional System
• Agricultural and hunting societies.
• There is little room for innovation or
change.
• They tend to lack modern conveniences
and have a 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
• “An Inquiry into the Nature and Causes of
the Wealth of Nations” (1776)
– 10 years to write
– 5 volumes
• “Laissez faire”
• The Invisible Hand
– Self Interest (Motivating Force)
– Competition (Regulating Force)
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
• Radical approach to fix the problems in free
market systems
• Communist Manifesto (1848) with Frederick
Engels.
• 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 create a classless society.
KARL MARX(1818-1883)
Frederick Engels
Karl Marx
The Soviet Union
• The Bolshevik
Revolution (1917)
• Lead by Vladimir
Lenin
• Creates a centrally
planned economy
The Soviet Experiment
• Factors of production controlled by the state
• Resources= armed forces, space program, capital
goods
• Government committees decided the quantity,
process and distribution of products
• The government created large state-owned farms
and collectives
• Little incentive to produce, decline in the
production of goods.
Problems in Centrally Planned Economies
• Poor-quality goods, shortages, and
diminished production
• Fail to meet consumer needs and wants
• Little individual incentives to work
• Lack of innovation
• Expensive and inflexible government
structure
• Sacrifice of individual freedoms
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
Chapter 3 and 13
American Free
Enterprise
Understanding America’s
Economic Structure
Tradition of Free Enterprise
The Economic Trade-off (Freedom
vs. Protection): Americans have
favored economic freedom over
economic regulation, but we still expect
the government to protect us from the
problems that can exist in free markets
(market failure, externalities)
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
Poverty
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.
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
The Bureau of Labor Statistics
determines the unemployment rate (% of
the labor force that is unemployed) each
period
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
job, but have given up looking for one.
Full employment is the level of employment reached
when there is no cyclical unemployment.
Going….UP!!!!!!!!!!
• Inflation is a general increase in
prices.
• Inflation limits purchasing
power (the ability to purchase
goods and services).
To Market, To Market
• The consumer price index (CPI) is
computed each month by the Bureau of
Labor Statistics.
• This is a measure of the price of a typical
consumers “market basket”.
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
1. Quantity
Theory
2. Demand-Pull
3. Cost-Push
What’s the big deal?
The three main problems caused by inflation are:
–Reduced Purchasing Power
–Erosion of Interest Income
–Erosion of Wages/Income
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
Who does the government provide
a safety net for?
Elderly
Disabled
Children
Poor
Redistribution Programs
Type of Program
Description
Example
Cash Transfers
Direct payment of cash to qualifying Temporary
individuals
Assistance to
Needy
Families
Unemployment
Compensation
In-Kind Benefits
Goods and services for free or
reduced prices
Subsidized
housing
Medical Benefits
Health insurance to those that cannot Medicare
provide it for themselves
Medicaid
Education Benefits
Federal, state, and local government
all provide money for the poor and
disabled to ensure all people receive
educational opportunities.
Head Start
Food Stamps
Pell Grants
Example