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Economic Systems
Unit 2
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?
Examples

How should these goods and services be
produced?
Examples

Who consumes these goods and services?
Examples
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
4Economic 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,
In a market economy
how to produce it, and to
economic decisions are
whom to distribute it.
made by individuals and
are based on exchange, or
In a centrally planned
trade.
economy the central
government makes all
decisions about the
production and
consumption of goods and
services.
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
 Mixed
Planned


Custom
Individuals
Central Government
Individuals with some
government
involvement
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
 In
a free market
economy,
households and
business firms use
markets to
exchange
money and
products.
 Households
own the factors
of production
and consume
goods and
services.
Circular Flow Diagram of a Market Economy
monetary flow
physical flow
Households
Firms
physical flow
monetary flow
“The Father of Economics” Adam Smith (1723-90)
 Laissez
Faire
 Scottish social
philosopher/professor
 “The Wealth of Nations”
(1776)
 10 years to write/5 volumes
 Established Economics as its
own discipline
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.”
Back to
Principles
Advantages of the Free Market
1.
2.
3.
4.
Freedom
Efficiency
Growth and Innovation
Variety of Goods and Services
Centrally Planned Economies
Definition ~The government, or a central authority,
controls the factors of production.
Organization of Centrally Planned Societies
Modern Day Forms of Central Planning:
 Socialism~ a social and political philosophy based on
the belief that democratic means should be used to
distribute wealth evenly throughout a society.
 Communism~ 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.
Communist Theory (Today, Marxism):
Karl Marx (1818-1883)
 German
philosopher, political economist and historian
 Developed radical approach to understanding and coping
with the problems that occurred in free market systems,
namely the Industrial Revolution
 Published the Communist Manifesto in 1848 with Engels
 He argued that history is a series of class struggles between
the rich capitalists and the working class.
 He believed that eventually workers needed to unite and
revolt against the capitalists. This revolution would then
breed a classless society.
Philosophy Becomes Reality: The Soviet Union
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.
Advantages and Disadvantages of
Centrally Planned Economies
Advantages
Disadvantages
1. Public goods and services
provided by the state (i.e.
healthcare, education,
housing)
2. Wasteful competition is
avoided
3. Peaceful labor conditions
4. Welfare of citizens is the
primary goal of the state
5. Business cannot act against
the interest of the people
1. Poor-quality goods and
shortages
2. Failure to meet set ideals/
consumer needs
3. Lack of incentive to work
hard
4. Lack of innovation
5. Expensive and inflexible
government
6. Sacrifice of individual
freedoms for society
Mixed Economies
 Most
modern economies mix features of both
systems (centrally planned and free market).
 An economic system that permits the conduct
of business with minimal government
intervention is called free enterprise.
 This is the system that exists in the United
States and most industrialized nations
throughout the world.
 How do mixed economies differ? For example
consider the United States and France.
American Free Enterprise
(Freedom vs. Protection)
Tradition of Free Enterprise
 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.
 All Americans act to decide when the
benefits of government protection
outweigh the drawbacks to free
enterprise.
Constitutional Protections
 Property
Rights
 Contracts
 Taxation
The Role of the American Consumer
Roles
 Consumer
 Voter
The Role of Government
1. Protect the Public Interest
2. Provide Information
3. Promote Growth and Stability
Key
Indicators of
Economic
Health
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
1.
2.
3.
Non-market activities
Underground economy
Quality of life
GDP vs. GNP
Annual income earned by
US owned firms and citizens.
Types of Unemployment
•
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
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.
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
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:
1.
FOOD AND BEVERAGES
2.
HOUSING
3.
APPAREL
4.
TRANSPORTATION
5.
MEDICAL CARE
6.
RECREATION
7.
EDUCATION AND COMMUNICATION
8.
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
Impact of Inflation
High inflation is a major economic problem,
especially when inflation rates change
greatly from year to year. The three main
problems are:
1.
2.
3.
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
Welfare Programs
o Welfare is a general term that refers to
government aid to the poor
o 1930’s- Under Roosevelt the
government began welfare programs
to reduce the impact of the Great
Depression.
o 1960’s- Lyndon Johnson launched the
“War on Poverty”
o 1990’s- Clinton transformed welfare
program to Temporary Assistance to
Needy Families (TANF)
Redistribution Programs
Type of Program
Description
Example
Example
Cash Transfers
Direct payment of cash to
qualifying individuals
Temporary
Assistance to
Needy
Families
Unemployment
Compensation
In-Kind Benefits
Goods and services for free
or reduced prices
Food Stamps
Subsidized
housing
Medical Benefits
Health insurance to those
that cannot provide it for
themselves
Medicare
Medicaid
Education Benefits
Federal, state, and local
government all provide
money for the poor and
disabled to ensure all
people receive
educational opportunities.
Pell Grants
Head Start