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Economies in Transition • Key Concepts • Summary ©2005 South-Western College Publishing 1 What will I learn in this chapter? You will learn the three basic types of economies, traditional, command and market, then you will examine the pros and cons of the “isms”— capitalism, socialism, and communism. 2 What is an economic system? The organization and methods used to determine what goods and services are produced, how they are produced, and for whom they are produced 3 What are the basic types of economic systems? • Traditional • Command • Market 4 What is a traditional economy? A system that answers the What, How, and For Whom questions the way they always have been answered 5 What is the benefit of a traditional economy? There is little friction among members because relatively little is disputed 6 What are the disadvantages of a traditional economy? Restricts individual initiative Lack of advanced goods, new technology, and growth 7 What is a command economy? A system that answers the What, How, and For Whom questions by central authority 8 What is the structure of a command economy? It has a pyramid structure 9 The Command Economy Pyramid Supreme planning agency Specialized planning agencies Producing units Consuming units 10 What are the strengths of a command economy? Economic change can occur very quickly Social welfare can be enhanced 11 What are the weaknesses of a command economy? Decision makers have the power to be absolutely wrong Quality and variety of goods suffer 12 Price per side mirror (rubles) Central Planners Fixing Prices $80 S Shortage of 400 thousand side mirrors $60 $40 $20 Price set by planners E D 200 400 600 800 1000 Quantity of side mirrors (thousands per day) 13 Shortage of mirrors Planners set the price of mirrors below equilibrium 14 What is a market economy? An economic system that answers the What, How, and For Whom questions using prices determined by the interaction of the forces of supply and demand 15 Who was Adam Smith? The father of modern economics who believed that a free market economy acted like an “invisible hand” 16 What is the invisible hand? A phrase that expresses the belief that the best interests of a society are served when individual consumers and producers compete to achieve their own private interests 17 What is the advantage of a market economy? It provides a wide variety of goods and services that buyers and sellers exchange at the lowest prices 18 What are criticisms of a market economy? • Lack of competition • Externalities • Lack of public goods • Income inequality 19 What is a mixed economy? An economic system that answers the What, How, and For Whom questions through a mixture of traditional, command, and market systems 20 What is capitalism? An economic system characterized by private ownership of resources and markets 21 What is consumer sovereignty? The freedom of consumers to cast their dollar votes to buy, or not to buy, at prices determined in competitive markets 22 What is communism? A stateless, classless economic system in which all the factors of production are owned by the workers and people share in production according to their needs 23 Who was Karl Marx? His criticism of capitalism advanced communism 24 What is socialism? An economic system characterized by government ownership of resources and centralized decision making 25 What are the characteristics of socialism? Public ownership Centralization 26 What are the strengths of socialism? • An equitable distribution of income • Rapid growth is possible • No unemployment 27 What are the weaknesses of socialism? Inefficiencies occur Absence of entrepreneurship stifles growth 28 A Classification of Economic Systems China, Russia Pure socialism Cuba, N. Korea U.S., Canada, W Europe, Japan Pure capitalism France, Mexico, Latin Sweden, America Israel Hong Kong 29 Key Concepts 30 • • • • • • • • • • • What is an economic system? What are the basic types of economic systems? What is a traditional economy? What is a command economy? What is a market economy? Who was Adam Smith? What is the invisible hand? What is a mixed economy? What is capitalism? What is communism? Who was Karl Marx? What is socialism? 31 Summary 32 An economic system is the set of established procedures by which a society answers the What, How and For Whom to produce question. 33 Three basic types of economic systems are the traditional, command, and market systems. 34 The traditional system is based on decisions made according to custom, and the command system answers the three economic questions through some powerful central authority. 35 In contrast, the market system uses the impersonal mechanism of the interaction of buyers and sellers through markets to answer the What, How, and For Whom questions. 36 The Command Economy Pyramid Supreme planning agency Specialized planning agencies Producing units Consuming units 37 Capitalism is an economic system in which the factors of production are privately owned and economic choices are made by consumers and firms in markets. As prescribed by Adam Smith, there is an extremely limited role for government, and self-interest is the driving force, held in check, or regulated, by competition. 38 Consumer sovereignty is the determination by consumers of the types and quantities of products that are produced in an economy. 39 Socialism is an economic system in which the government owns the factors of production. The central authorities make the myriad of society’s economic decisions according to a national plan. The collective good, or public interest, is the intended guiding force behind the central planners’ decisions. 40 Communism is an economic system envisioned by Karl Marx to be an ideal society in which the workers own all the factors of production. Marx believed that workers who worked hard would be public spirited and would voluntarily redistribute income to those who are less productive. Such a communist nation described by Marx does not exist. 41 END 42