Economic Systems

Unit 3

3 Fundamental Economic Questions

• What goods and services are to be produced?Vanuatu is a small island in the South Pacific. Their economy has always been based on agriculture but now their tourism is growing. They must decide what they will put their limited resources towards. https://www.youtube.com/watch?v=TEB4mAonQXA

3 Fundamental Economic Questions

• How are goods and services produced?What combination of the factors of production will be used to create the goods and services of a society. In the U.S. most businesses get to decide this for themselves, but that is not the case in all societies.

3 Fundamental Economic Questions

• For whom are goods and services to be produced?Who gets what? Who deserves what?• Goods and services are distributed in a variety of

ways:– Ability to pay-what we are used to– Equal distribution-U.S.S.R.– First come; first served– Distribution according to need

Economic Goals

• A society’s answers to these questions will depend on their values and economic goals

• Economic Freedom-we place a high value on the ability to make our own decisions without interference

• Economic efficiency-all societies want to make the best use of its resources. Full employment is a goal for all societies

Economic Goals

• Economic equity-this goal is difficult to achieve because there are differing definitions of equity– Some regard economic equity as everyone having an

equal opportunity to achieve economic prosperity– Some believe economic equity means everyone gets their

fair share of the economic pie; equal distribution of economic wealth

– As of 2011…the top 1% of the United States owns 43% of the wealth in the nation.

http://www.washingtonpost.com/blogs/wonkblog/files/2013/09/Ae0VQFM.gif

Economic Goals

• Economic growth- societies all want to increase the amount of goods and services that are produced

• Economic security- this is another goal where many disagree about its importance– All societies have members who cannot provide for

themselves– How a society decides if or how they will take care of

those who can’t take of themselves will depend on what it values

Economic Goals

• Economic Stability- every society wants their goods and services to be available to those who need or want them

• Stability occurs when everyone has access to the goods and services they need

Economic Systems

• An economic system is the way a society coordinates the production and consumption of goods and services

We will learn about 4 different type of economic systems in this unit:• Traditional• Command• Market• Mixed

Command-Centrally controlled, where the

government makes all economic decisions (Security, Equity)

Market-Consumers drive all the economic

decision(Freedom, Efficiency)

Traditional-Family or

community based economic system

that relies on custom or ritual to

drive economic decisions(Stability,

Security)

Mixed-Consumers and the government drive all

the economic decision

4 Economic Systems

Traditional Economies

• First and oldest economic system• Most current traditional economies that survive today

belong to indigenous people who live much like their ancestors did hundreds of thousands or thousands of years ago

• Masai of East Africa measure wealth in terms of cattle and children; they are semi-nomadic herders

• The highest goals of a traditional economy are economic security and stability

https://www.youtube.com/watch?v=e8JzaVbdxTI&list=PLBEgyQ49zuIegSWCemPQWxYjP3GlFBfNe

Command Economies• In a command economy the decisions about

what, how, and for whom to produce goods and services are made by a powerful ruler or some other authority

• The four River Valley Civilizations were all command economies

The Industrial Revolution and Capitalism

• During the Industrial Revolution new inventions and manufacturing created growth in industries

• Investors-capitalists- grew wealthy by accumulating capital; machines, factories, railroads. Capitalism is now the term synonymous with the free market system used during the Industrial Revolution

• Standards of living improved for most but many blamed the capitalists for exploiting workers and keeping them in poverty

Reaction to Capitalism• After the Industrial Revolution

there were pushbacks to capitalism

• In 1848 Karl Marx and Friedrich Engels published the book The Communist Manifesto which advocated the overthrow of capitalism

http://10.202.3.241/SAFARI/montage/playlistedit.php?SearchType=my&Action=MakeActive&playlistkeyindex=11177&location=local&newlessonfromplaylist=

Socialism/Communism in Theory• Their book advocated socialism and then communism• Socialism- a political and economic philosophy that

calls for property to be owned by society as a whole for the equal benefit of all

• Communism-(would be the final phase of socialism)- a political and economic system in which all property and wealth are owned by all members of the society. No class differences.

• “From each according to his ability, to each according to his needs.”

Communism in Practice• The U.S.S.R. became the first modern command

economy in 1917.• It became an authoritarian oligarchy controlled by

the Communist Party leaders• Private ownership of property was forbidden.• The state owned the factors of production• Economic planning was done by government

committees of economists, production experts, and political officials who attempted to perform the function of markets.

http://10.202.3.241/SAFARI/montage/playlistedit.php?SearchType=my&Action=MakeActive&playlistkeyindex=11177&location=local&newlessonfromplaylist=

• The committees decided how to use the factors of production, what would be produced, for whom it would be produced, and they also set prices and wages.

• This was supposed to ensure economic security and equity

• This ignores the incentives matter principle- no way to fire bad workers and no way to reward productive workers

• Led to shortages and low quality products• Eventually the economy collapsed leading the end of the

USSR • China is now the largest command economy in the worldhttp://www.youtube.com/watch?v=InqAzvX6UrI

Market Economy• Market economy depends on the decisions of

individual producers and consumer to coordinate its activities

• “the Market”- the economic system where buyers and sellers exchange goods and services

• Free market- no one single person, government, business tells producers and consumers what to do

Circular Flow Model• Household- a person or group of persons living

together; Households own the factors of production• Firm- an organization that uses these factors to

make and sell goods or services• The model uses two kinds of markets• Product market- goods and services are sold by

firms and purchased by households• Factor market- households sell their labor, land, and

capital to firms• Factor payments- wages for labor, land rental, stock

investments, etc.

20Product Market

Factor Market

Businesses IndividualsGoods and Services

$$$ Revenue $$$ $$$ Spending $$$Goods a

nd

Services

SUPPLYDEMAND

DEMANDSUPPLY

$$$ Costs $$$

Resources

$$$ Income $$$Resources

(Factors of

Production)

Mixed Economy• Mixed economy- both the government and

individuals play roles in regard to production and consumption

• Every nation with a mixed economy must choose its own balance between market freedom and gov’t involvement

• At minimum, gov’t is needed to establish the institutions that enable the markets to function– Legal system for laws and contracts– Currency system-Federal Reserve Bank

Government Involvement• Some countries want their governments to get

more involved in the economy:– Child labor laws– Regulation of pollution– Regulation of drugs, food, cosmetics

• Public Works- certain goods and services that governments can provide that markets do not always provide or do not provide enough of• Dams, highways, sewer systems, bridges, etc. • The markets do not provide them because the cost

of providing them “could never repay the experience to any individual or small number of individuals” Adam Smith

Government Involvement

• Different countries offer different things to their citizens, in Canada and much of Europe they offer:–Health to every citizen–College education to every

citizen–Day care to every family

Flow of Money in a Mixed Economy• Governments enter the flow in numerous ways• They purchase land, labor, and capital from households in the

factor market• U.S. government employs 2 million people; nation’s largest

employer• Gov’t purchases goods and services from firms in the product

market• U.S. government is also nation’s largest consumer • Governments will also produce goods and services; libraries,

schools, police stations, museums• Gov’t will then transfer money back to households• Social security checks, welfare payments, and unemployment

benefits are transfer payments

Characteristics of the U.S. Economy

• Free enterprise system- individuals own the factors of production and make decisions about how to use those factors within the framework of the law

• Characteristics of Free Enterprise system– Economic Freedom– Competition– Equal opportunity– Binding contracts- agreements between buyers and

sellers

• Property rights- the rights to own land, buildings, or other goods to use or dispose of them as they choose• intellectual property- creations of the mind that have

commercial value• Patents-gives an inventor the sole right to make, use, or

sell his or her invention• Copyright- gives the creator of a literary or artistic work

the sole right to reproduce, distribute, perform, or display the copyrighted work

• Profit Motive- the desire to make a profit• Profit is the money earned by a business after

subtracting the costs of operation

• Limited Government– Protecting property rights and contracts– Promoting the general welfare– Preserving competition– Protecting consumers, workers, and the

environment– Stabilizing the economyWe as a nation are still deciding to what extent we want our government to get involved in the economy.