chapter 2: economic systems and decision makingschools.misd.org/upload/template/12139/docs/notes/ch....

CHAPTER 2:

ECONOMIC SYSTEMS AND

DECISION MAKINGLesson 1: ECONOMIC SYSTEMS

ECONOMIES BASED ON TRADITION

o Much of what we do springs from habit and custom.

Characteristics:

o In a society with a traditional economy, the use of scarce

resource stems from ritual, habit or custom.

o Habit and custom dictate most social behavior.

o Roles are defined by the customs of their elders and

ancestors rather than by choice of the person.


Examples:

o The Inuit of Northern Canada in the 19th century.

o When the Inuit hunted, it was traditional to share the spoils of the

hunt with other families. Hunters divided the kill evenly into as

many portions as there were heads of families in the hunting

party. The hunter most responsible for the kill had 1st choice, the

2nd hunter to help with the kill chose next and so on.

o As a result, the hunter had the honor of the kill and the respect of

the village, rather than a physical claim to the entire animal. This

custom was partially responsible for the Inuit’s survival for

thousands of years.


Advantages:

o Little uncertainty exists over WHAT to produce. If you are born

into a family of hunters, you hunt and so on.

o Likewise, little uncertainty exists over HOW to produce, because

you do things much the same way your parents did.

o Finally, the answer to the FOR WHOM question is determined by

the customs and traditions of the society.

o In some societies, you would provide for your immediate family

while in others you might share what you have with other families

in the village.


Disadvantages:

o A traditional economy tends to discourage new ideas. Lack of

progress due to lack of new ideas leads to economic stagnation

and lower standards of living.

o The strict roles in a traditional society have the effect of

punishing people who act differently or break the rules.

ECONOMIES BASED ON COMMAND

o In a command economy, a central authority makes the major

decisions about WHAT, HOW and FOR WHOM to produce usually

by a king, dictator, president or anyone else who makes the

major economic decisions.

o A modern and liberal version of the command economy is

socialism—a economic economic system in which the

government owns some, but not all, of the factors of

production. The government plays a major role in answering

most of the major WHAT, HOW, and FOR WHOM questions.


Characteristics:

o In a pure command economy, the central authority makes all of

the major economic decisions (ex: whether to build housing and

how to build it).

o Sometimes the central authority is generous with the country’s

wealth but in other cases, much of the country’s wealth is kept

for the exclusive benefit of its leader. Such countries often

have a culture where citizens use bribery to obtain the smallest

portions of goods.


Characteristics (con’t):

o Most command economies severely limit private property rights.

Because of this, the government owns most of the resources in the

economy.

o Socialist economies share many of the same characteristics of pure

command economies; only fewer resources are owned/controlled

by the central authority.

o Most socialist economies tend to be larger than economies

directed by pure tradition making it harder for the government to

own and direct everything.

o Conclusion: major economic decisions are made FOR the people.


Examples:

o Examples of pure command economies are limited to a handful.

o North Korea is perhaps the world’s last leading example of a

command economy where everything—even the media and

tourism—is either owned or controlled by the government.

o The small and shrinking # of countries based on communism

include Cuba, Vietnam, Venezuela and the former USSR which

collapsed in 1991.

o Denmark, Sweden and Norway are not socialist anymore but still

have a few features such as free health care.


Advantages:

o A major strength of a command system is that it can change

direction drastically. The former USSR went from a agricultural

society in 1910 to a industrial decades in a few decades. The

central planners were able to shift resources on a massive scale.

o Another advantage of a socialist command economy is that it

allows most citizens to receive some goods and services that they

would otherwise not be able to afford (universal health care, basic

food, electricity, education, transportation) at little to no cost.


Disadvantages:

o Command economies have several major disadvantages.

o 1st - leaders of command economies usually provide for

themselves at the expense of the general population while

the average citizen may be forced to go without.

o The current North Korean government puts a strong

emphasis on defense spending while their people have

suffered years of hunger. At times, the government even had

to accept food aid from international sources.


Disadvantages (con’t):

o 2nd - is the loss of the individual freedom to choose. In Cuba,

doctors are required to live in the same buildings where they

provide their services.

o State-controlled media, such as radio and TV, has programming

limited to the content that the government wants its people to

see, not open to what the people would choose to see. In North

Korea, living conditions in other parts of the world are not

shown, because the government wants its people to think that

they live in a advanced society.



o 3rd – the production of low-quality goods. Workers focus on

filling quotas rather than producing quality goods.

o The Soviets also made some of the most beautiful chandeliers in

the world. However, the quotas for those were also measured in

terms of weight, so the chandeliers were also some of the

heaviest in the world. Many were so heavy that they could not

be safely secured to the ceiling.



o 4th - an economy with major elements of command requires a large decision-making bureaucracy needed to make the production and distribution plans for even the most basic products. This structure slowed decision making.

o In Venezuela—a modern economy tending toward socialism under Chavez—entire industries in the agricultural, financial, oil, and steel sectors were taken over by the government. These industries also required supervision by politicians who were making decisions to satisfy political goals, regardless of the economic impact of their decisions.



o 5th - rewards for individual initiatives are rare in both command

and socialist economies. In the early years of the Soviet Union,

all workers were paid about the same, regardless of their

occupation or how hard they worked in each profession. Doctors

were paid about the same as factory workers.

o The result—and a very important one—is that economies with

relatively uniform wages for different occupations and effort do

not provide much incentive for people to learn or work.



o 6th - a planning bureaucracy lacks the flexibility to deal

promptly with major problems, or even minor day-to-day ones.

As a result, command economies tend to lurch from one crisis

to the next—or collapse completely.

o Almost all countries are connected by foreign trade, so it is

possible for a problem in one part of the world to be quickly

transmitted to another. Something like rapidly rising oil prices

because of a hurricane in the Gulf of Mexico is bound to have a

worldwide impact on countries far away.



o Finally, pure command economies tend to stay relatively small

because they have such a hard time making all of the decisions

necessary for growth and change to take place.

o Goods and services are never free, even if the country has an

economy directed by socialism. In more developed European

countries such as Denmark, Sweden, and Norway, programs like

free education and national health care are funded with high

domestic tax rates. As a result, the tax rates in these countries

are higher than those in the United States.

ECONOMIES BASED ON MARKETS

o A market is an arrangement where buyers and sellers interact

to determine the prices and quantities of goods and services. A

market can exist as long as a mechanism is in place for buyers

and sellers to interact.

o A market economy is one in which the WHAT, HOW, and FOR

WHOM questions are primarily answered by people who make

supply and demand decisions in their own best interests.


Characteristics:

o A market economy is characterized by a great deal of freedom.

People can spend their money on the products they want most.

o A market economy is often described as being based on

capitalism—an economic system where private citizens own and

use the factors of production for their own profit.

o The term capitalism draws attention to the private ownership

of resources, while the term market economy focuses on where

the goods and services are exchanged.


Examples:

o Australia, Canada, Great Britain, Japan, Singapore, South

Korea, parts of Western Europe, and the United States, are

based on markets and capitalism. While there are significant

differences among them, these economies share the common

elements of markets and the private ownership of productive

resources to seek profits.


Advantages:

o 1st - high degree of individual freedom. People are free to spend their money on almost any good or service they choose. People also are free to decide where and when they want to work, or if they want to invest further in their own education and training.

o 2nd - it adjusts gradually to change over time. The decision that individuals made themselves—not decisions made by government planners—helped the economy adjust to change.

o 3rd - the relatively small degree of government interference…except for certain concerns such as justice and national defense.


Advantages (con’t):

o 4th - decision making is decentralized. Trillions of individual

economic decisions are made daily, so everyone has a voice in

the way the economy runs.

5th - the variety of goods and services that are produced. If a

product can be imagined, it is likely to be produced in hopes

that people will buy it.

6th - the high degree of consumer satisfaction. In a market

economy, the choice one group makes does not affect the

choices of other groups


Disadvantages:

o The market economy does not provide for everyone. Some

people may be too young, too old, or too sick to earn a living or

to care for themselves.

o A market economy also may not provide enough of some basic

goods and services. This is because private producers

concentrate on providing products they can sell for a profit.

o Finally, a market economy has a high degree of uncertainty.

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