Unit 1

Rationing SystemEconomic systems

Rationing System

• The central issues of opportunity costs and scarcity lead to choice. This in turn leads to the questions of how these choices are made.

• The solution is man-made; economics systems. • The purpose of the system is to fulfill wants by

using factors of production, which by their nature of scarcity mean that all wants cannot be satisfied. Somehow the goods must be rationed.

Basic Economic Question:

• What to produce? • How to produce? • For whom to produce?

OR • What to produce; • How to produce it; • Who shall receive it.

“What”

• The first issue, “what”, deals with the allocation of resources to make the goods that society wants.

• The issue can be as trivial as “red shoes or blue shoes” or as broad as the classic “Guns or butter”.

“How” and “Who”

• The issue of “how” deals with production methodology, organization and technology. The final issue, “who”, is the wider issue of distribution basically who gets the “stuff”

• All societies have to deal with these issues.

Mixed Economies

• First of al it is important to understand that all economic systems are “mixed economies”; it is simply the degree to which markets and government planning address the basic economic question.

• Most of this of the ‘mix’ is the result of the ideology and politics of the respected country.

Public

• Public sector and Public ownership are inextricably linked but not identical.

• The public sector is state, regional, local, and municipal governments. This comprises judicial system, military and civil defense, tax authorities, road workers, health care, schools, nurseries.. .and anything funded by monies from state/regional/municipal government.

Public ownership

• Public ownership overlaps most of the activities within the public sector but often has a far more specific meaning.

• Public ownership is when government has ownership or control of firms.

• This was popular post WWII in Europe, but was scaled back during the 1980’s in both the USA and the UK.

Arguments for public interest and control

• Political argument states that additional benefits to society result from government provision and control of certain goods. Governments can provide services available to all rather only to those who can afford them.

• They can also use taxes and social benefits to even out disparities.

• The economic argument focuses on the inability of the private ownership to produce the “right” amount of the good or at the “right” cost of the good.

• They would ether under produce certain goods, (missing market) or would produce certain good that are harmful to society.

• Taxes may be introduce to control this. (Tobacco, alcohol)

Private (Self interest)

• Most democracies have the rule of property rights included in their constitution or laws.

• It allows the owner to act in his or her self interest in order to make a profit.

So how does private ownership work?

• Firstly, (and most evident) firms create the goods and services desired by society.

• No firm will in the long run use resources (= accrue costs) without compensation (= revenue and profit).

• Secondly, the firm adds value to basic resources. As raw materials are passed through the production system, labor and capital add value at every level.

• Thirdly the effect on the economy – the workers receive a salary, and the firms, factories all receive revenues.

• This becomes the national income, which allows society a wide range of choices

• The income also is taxed which provides social benefits to society.

• Fourthly, the drive for profit creates new products.

• Research and development (R & D) has become a major factor in the long run profit strategies of firms.

• There is a huge incentive for firms (or individuals) to create new and/or better products.

• And lastly new RD developments results in new technology which improve the use of resources and the firm / individual become more productive.

• (Thank goodness for the computer)

Central Planning versus

Free Market

Price Mechanism

• In a competitive market system, entrepreneurs figure out a business plan with profit as the goal and set the price of a product based on cost of resources.

• Consumers also help set the price by choosing at what price they are willing to buy the product, this is the price mechanism that is central to the market system.

Rationing Mechanism

• A side effect of price mechanism is that it also decide who will get the products.

• Higher demand will lead to scarcity which will create a higher price, just as falling prices will allow more people to buy the product.

• Companies and firms will be forced to become efficient to be able to produce goods cheaper, and those that can’t do this are forced to leave the market.

Definition

• The price mechanism is a competitive market acts as a signal for suppliers to increase or decrease supply, ultimately creating equilibrium between supply and demand and optimal allocation of resources. The price thereby also acts as a rationing method, limiting goods distribution of the basis of those consumers who can afford to obtain the good. (McGee 62)

Planned and “Command” Economies

• In the socialist, planned economies, markets have far less to do with output decisions as this is primarily in the hands of centralized government bureaucrats.

• The production factors are owned and/or allocated by the state and complex planning mechanisms are formalized in the hierarchical architecture of the state, such as committees assessing demand, assigning output, setting production targets/quotas and subsequent pricing of the goods.

• Generally, the system was based on a centralized system of three stages:

• 1) assessment of demand by central planning committees;

• 2) setting of production targets;• 3) doing an input/output analysis in order to

determine the amount of resources necessary to produce the target quantity of goods.

• In addition to this, prices on output were set at central level, which for the most part meant that the price of goods never matched the corresponding use of factors of production.

Ideology

• The founding ideological base of socialism was one of equality and the good of the collective rather than the individual.

• This meant that every citizen had the right to employment; many prices were set very low in order for everyone to afford the goods;

“Just a theory” • Neither of these two systems actually exists.• Planned economies always had to overlook that

at some point in most industries, private consumption was supplied by private enterprise.

• On the other side a “free” market does not exist with only private roads, electricity plants, and anything and everything being allowed to be made and sold. (lets not get started with what just happened with AIG.)

Economies in transition

• Many of the former Soviet Union States, and of course China have started the process (or finished it) from, a Command Economy, towards becoming more of a Free- Market Economy.

Problems of Transition• Some of the general problems according to Matt McGee.1. All the transition economies in Central and Eastern Europe

and the former Soviet Union have experienced falling output and in many cases prolonged negative growth, i.e. shrinking economies.

2. Corruption has been ever-present in most former command economies, as governments and institutions collapsed leaving a judicial vacuum. The EBRD Transition Report from l997 said former Soviet (Russia and Ukraine amongst others) corruption levels were the highest in the world.

3. Lack of legal institutions has meant difficulties in both setting and collecting taxes and affirming ownership, both of which impaired the creation of viable companies to replace defunct government run enterprises.

4. Lack of financial institutions (e.g. banks) and capital markets often meant that good businesses collapsed due to lack of loanable funds, and that start-up companies could not get initial loans.

5. This problem was exacerbated by people simply being unaccustomed to a market economy with the ensuing competition. It sounds perhaps simplistic, but has had a very real impact on these countries’ ability to adapt.

6. High inflation rates resulted from prices being set free which helped cause falling exchange rates. The net effect was a redistribution of incomes at best — and at worst an obliteration of years of saving. Those on fixed incomes fared particularly ill, e.g. pensioners.

7. Entrenched former party officials were often able to use connections to enrich themselves in the ‘cowboy capitalism’ prevalent in cases where the fall of the command system came swiftly. This added to already increasing differences in income and wealth. The result was often highly unequal income distribution

8. Rampant inflation often led to falling exchange rates. This created a chaotic situation where the combination of the two effectively made domestic currencies worthless creating a decline in trade. (Point in fact; Russia came very close to adopting the US dollar as its currency.)

9. As the monetary economy in some cases ceased to function, barter economies took over sizable portions of economic activity. This is a most wasteful and time consuming system when applied across a large portion of the economy.

10.Linked to the barter system, black markets and organized crime gained a foothold in many former planned economies. Estimates of the black market share of total economic activity in Russia in the late 1990s varied form one fourth to one third.

10. Illegal gains, high inflation and increasingly worthless currencies all aided and abetted massive capital flight, i.e. monies were sent to other countries. This also led to a vicious circle in terms of the economies lacking necessary funds for domestic investment.

11. Finally, most of the former planned economies saw increased unemployment. State owned firms declined as they were subjected to competitive forces, letting workers go. Hidden unemployment became very apparent. At the same time, demand for domestic goods was falling which further lowered demand for labor which in turn lowered incomes. Few of the countries involved had sound social safety nets to deal with the problem.

Sources

• McGee, Matt: Economics - In terms of The Good, The Bad and The Economist. Victoria: IBID P, 2004.