Chapter 2

ECONOMICS

3 BASIC QUESTIONS OF ECONOMIC SYSTEMS

1. What to Produce?– Should a society direct most of its resources to the

production of military equipment or to other items such as food, clothing, or housing?

2. How to Produce?– Should a society direct most of its resources in

machinery or use less machinery to employ more workers and lower unemployment?

3. For Whom to Produce?– Once a society decides what to produce and how to

produce it they must decide who is going to get it and who is going to share in what is produced.

ECONOMIC SYSTEM•An organized way a society provides for the wants and needs of its people.

3 TYPES OF ECONOMIC SYSTEMS1. Traditional

– an economic system based on customs, beliefs, habits, and sometimes religion. Almost all economic activity and societal behavior is dictated. Individuals are not free to make decisions based on what is wanted or what they like. Instead, their roles are defined by the customs and rituals.• Examples: the central African Mbuti, the Australian Aborigines, and northern Canada’s

Inuits.

2. Command– an economic system where all of the decisions about the nation’s economy is

made by the government.• Examples: North Korea, Cuba, People’s Republic of China, and Vietnam

3. Market– an economic system where there is freely chosen activity between buyers and

sellers of goods and services. This is where the types and prices of goods and services produced are determined by the dollar notes cast in the market place by the consumer. People are free to decide for themselves what good and services will be purchased.• Examples: United States, Canada, Japan, South Korea, Singapore and parts of Western

Europe.

ADVANTAGES OF TRADITIONAL ECONOMIC SYSTEM

1.Everyone knows which role to play.

2.Tradition dictates how people live.

DISADVANTAGES OF TRADITIONAL ECONOMIC SYSTEM

1. It discourages new ideas and new ways of doing things.

2. Usually has a low standard of living.

ADVANTAGES OF COMMAND ECONOMIC SYSTEM

1. Can change direction drastically in a relatively short time

2. Health and public services are available for everyone at little or no cost

DISADVANTAGES OF COMMAND ECONOMIC SYSTEM

1. Is not designed to meet the needs of consumers

2. Does not give people incentive to work hard

3. Requires large decision-making bureaucracy

4. Does not have flexibility to deal with minor problems

5. Individual initiative is rarely rewarded

ADVANTAGES OF MARKET ECONOMIC SYSTEM

1. It can adjust to change2. Has a high degree of individual freedom3. Has a low degree of government

interference4. Decision making is decentralized and

not concentrated in a few people5. High variety of goods and services are

available to consumers6. High degree of consumer satisfaction

DISADVANTAGES OF MARKET ECONOMIC SYSTEM

1. Does not provide for the basic needs of individuals

2. Does not provide enough of the services that people value highly

3. High degree of uncertainty that workers and businesses face as the result of change

4. Must guard against market failures

MARKET ECONOMIES CAN FAIL IF THREE CONDITIONS ARE NOT MET

1. Markets must be reasonably competitive

2. Resources must be reasonably free to move from one activity to another

3. Consumers need access to adequate information so that they can weigh the alternatives and make wise choices

GOALS OF THE UNITED STATES’ MARKET ECONOMY1. Economic Freedom—freedom for people to make their own economic

decisions in the marketplace. This goal is highly valued in the United States.

• Individuals are free to choose their occupation or to not be employed,and how they spend their income, and the range of choice is larger becauseit is not limited by central planning decision; suppliers are free to supplyas they desire in the pursuit of profit.

2. Economic Efficiency—resources are used wisely and the benefits gained are greater than the costs incurred.

• Decisions of what is most valued are made by consumers; profit incentivesmotivate suppliers to respond to these consumer choices at the lowest possiblecost.

3. Economic Equity—fairly and justly treating everyone by not discriminating on the basis of age, sex, race, religion, or disability in employment.

• Individuals are free to choose their occupation or to not be employed;income depends upon the value created in the workplace; wage rates varyaccording to supply and demand and the dispersion in wages can producemore inequality than in a Command Economy.

GOALS OF THE UNITED STATES’ MARKET ECONOMY4. Economic Security—protection from poverty and emergency (social

programs like Social Security & Medicare).• Government in most developed market economies provides varying levels

of safety net programs to include health care, retirement benefits, schooling,unemployment compensation, disability, low-income family assistance.

5. Full Employment—providing as many jobs as possible.6. Price Stability—sometimes called freedom from inflation, is

important to anyone trying to provide basic necessities on a limited income and for anyone planning their economic future.

• When consumers are free to choose, changes in their purchases can setoff cyclical changes (up or down); counter-cyclical monetary and fiscalpolicies have been adopted by government.

7. Economic Growth—populations tend to increase and existing populations tend to want more goods and services.

• Individuals in pursuit of higher living standards and greater profitsprovide the core process by which growth takes place; government can encourageor discourage economic growth in choosing policies that promote or discourageincreases in productivity and technological advancement.

Trade-offs Among Goals• When goals are at odds, people must compare costs to

benefits before resolving the conflict. Most of the time, people, business, and government are able to work out conflicts among goals.

• For example, a policy that keeps foreign-made shoes out of the United States could help the goal of full employment in the local shoe industry. This policy might work against individual freedom, however, if people ended up with fewer choices of shoes to buy. Or, a new shopping center built near a highway may stimulate economic growth in one area of a community. At the same time, it could threaten the stability and security of merchants who run stores in the downtown area.

Capitalism•An economic system in which

individuals own the factors of production.

Free Enterprise• This is what the American economy

is. People are free to own and control the factors of production, free to make money, and free to lose money in your own endeavors. • Competition is allowed to flourish

with a minimum amount of government intervention.

POSITIVE ASPECTS OF A MARKET ECONOMY

1. High level of economic and personal freedom

2. High standard of living3. Diverse lifestyle

NEGATIVE ASPECTS OF A MARKET ECONOMY

1. Private businesses do NOT produce what is good for the consumer as a whole

2. Poor are seldom considered

5 CHARACTERISTICS OF A FREE ENTERPRISE ECONOMY1. Economic Freedom—people and businesses make their own economic choices.

– People have freedom to choose their occupation and employer. People can choose to won a business or work for someone else. Businesses have freedom to produce profitable goods/services and to hire the best workers.

2. Voluntary Exchange—the act of buyers and sellers freely and willingly engaging in market transactions.– Transactions are made in such a way that both the buyer and the seller are better off after the

exchange than before it occurred.

3. Private Property Rights—privilege that entitles people to own and control their possessions as they wish.– Private property includes both tangible items such as houses and cars, and intangible items such as

skills and talents.

4. Profit Motive (Incentive)—the force that encourages people and organizations to improve their material well-being. It is largely responsible for the growth of a free enterprise system based on capitalism.– Business owners and managers make choices themselves, operating in ways they believe will

maximize their profits. This forces management to exercise financial discipline because it makes people economically responsible for their own success or failure. It rewards innovation by letting creative companies grow, and it improves productivity by allowing more efficient companies to make more money.

5. Competition—the struggle among produces for the dollars of consumers; the rivalry among sellers to attract customers while lowering costs.

Role of the Entrepreneur in Capitalism• Entrepreneurs use land, capital, and labor

to make a profit. When an entrepreneur is successful, everybody benefits. Successful entrepreneurs attract other firms to the industry. The entrepreneur’s search for profits leads to new products, greater competition, more production, higher quality, and lower prices for consumers.

Role of the Consumer in Capitalism• Consumers have much power in a free

market economy. Consumer sovereignty describes the role of the consumer as ruler of the market. Consumers in the United States express their wants in the form of purchases in the marketplace. The dollars they spend are the “votes” used to select the most popular products.

Consumer Sovereignty• The power of consumers to

decide what is produced.

4 ROLES OF THE GOVERNMENT IN CAPITALISM

1. Protector—it may pass and enforce laws meant to prevent the abuse of consumers and workers.

• For example passes laws against false and misleading advertising, unsafe food and drugs, environmental hazards. Prohibits discrimination by employers based on age, gender, religion, or race. Protects property rights, enforces contracts, and make sure everyone follows the “rules of the game” to ensure an efficient and fair economy.

2. Provider & Consumer—all levels of government provide goods and services for its citizens and it also consumes factors of production.

• The U.S. government provides education and welfare and is the second larges consuming group in the economy.

3. Regulator—the government works to preserve competition and protect consumers.

• The U.S. government also oversees interstate commerce, communications, and even entire industries such as banking and nuclear power.

4. Promoter of National Goals—it is an important role of any government.• In the U.S., achieving economic equity and security has resulted in a mixed economy, or

modified private enterprise economy. Many of these government functions reflect people’s desire to modify the economic system to achieve the economic goals of freedom, efficiency, equity, security, full employment, price stability, and economic growth. Social security, laws on child labor, and the minimum wage, reveal how the U.S. has modified its free enterprise economy.

Mixed Economy (Modified Private Enterprise Economy)

• The United States is said to have a mixed economy because of modification and because there are some elements of tradition in the U.S. economy. • It is a free enterprise system with

some government intervention.