Chapter 2 – Economic SystemsResources are scarce everywhere, thus:Every country must answer three economic

questionsWhat goods and services should be

produced?How should these goods and services be

produced?Who consumes these goods and services?

Economic System – the structure of methods and principles a society uses to produce and distribute goods and services.

Economic Systems

Economic goals and societal valuesEvery society pursue each goal to some degree:

Economic Efficiency – maximize what can be producedcan’t be efficient unless you can provide the right goods to

the right people at the right timeEconomic Freedom – the opportunity for

individuals to make their own choicesEconomic Security – people want to know that

goods/services are available when needed and that they will get paid on timeSafety net – governments programs like workman’s

compensation, unemployment compensation, social security disability payments

Economic goals and societal valuesEconomic Equity – deciding who gets how

much payment. Each society is different.Economic Growth – economy should grow with

rising population and for individuals to have wage growthStandard of Living – level of economic prosperityInnovation – process of bringing new methods,

products, or ideas into useInstrumental in economic growth i.e. industrial revolution,

computer technology, etc.

Goals in Conflict – some goals undermine others i.e. safety nets can slow economic growth because they are expensive

Types of EconomiesTraditional Economy

Oldest and simplest economic systemRelies on habit, custom, or ritual to answer

three economic questionsLittle room for innovationRevolves around a family unitFound in small, close knit communitiesIndividuals work to support the community

not themselvesEx. Native Amazon tribes, African tribes,

some 3rd world nations

Chapter 2.1 QuestionsWhat is an Economic System?

What must happen for a nation’s standard of living to improve?

Why would it be inefficient for a manufacturer to produce audio cassettes instead of CDs today?

Which basic economic goals can be achieved easily in a traditional economy? Which cannot? Explain

Free Market SystemMarket – any arrangement that allows

buyers and sellers to exchange thingsThese allow us to exchange things we have

(money) for things we want (goods/services)Specialization – concentration of the

productive efforts of individuals and businesses on a limited number of activitiesThis leads to the most efficient use of capital,

land & labor

Free Market SystemFree Market Economy – answers to the

three economic questions are made by voluntary exchange in markets.Also known as Capitalist EconomyIndividuals and privately owned business

own the factors of production, make what they want, and buy what they want

Free Market SystemFactor Market – When firms purchase factors of

production from householdsHiring workersRenting land or buildings

Product Market – households buy the goods and services that firms produce

How does the marketplace function?Self Interest – buyers and sellers consider only their own

personal gain. This motivates people to act.Incentives – hope of reward or fear of penalty that

encourages a person to behave in a certain wayCompetition – the struggle among producers for the dollars

of consumersSelf interest and competition work together to regulate the

marketplace

Free Market SystemAdvantages of the Free Market:

Economic Efficiency – market responds efficiently to rapidly changing conditions

Economic Freedom – individuals work where they want, businesses produce what they want, households consume what they want

Economic Growth – competition encourages innovation, thus free markets encourage growth

Additional GoalsConsumer Sovereignty – the power of consumers to

decide what gets produced

There is no country in the world that has a truly “Free Market”

Chapter 2.2 QuestionsHow does specialization make us more

efficient?

How do self-interest and competition affect the free market?

Why do you think no country has a pure free market economy?

Centrally Planned EconomiesCentrally Planned Economy – the

government, rather than individual producers and consumers, answer the key economic questionsGovernment owns the land and capitalGovernment decides where people work and

what they are paidAlso known as a “Command Economy”Opposed to private property, free market

pricing, competition and consumer choice

Centrally Planned EconomiesTwo types of government associated with

Command EconomiesSocialism – not a single economic system;

rather, a range of economic and political systems based on a belief that wealth should be evenly distributed throughout society

Communism – central government owns and controls all resources and means of production and makes all economic decisionsSoviet UnionChina

Centrally Planned EconomiesDisadvantages of Centrally Planned Economies

Economic Efficiency – since government owns everything and fixes wages, workers lack incentive to work faster or produce more

Economic Freedom – individual freedoms sacrificed in order to pursue societal goals

Economic Growth – innovation is not promoted and they do not encourage entrepreneurship

Economic Equity – government officials are typically wealthy and workers are typically poor and suffer shortages

Additional Goals – has provided secure jobs and income

Chapter 2.3 QuestionsWhat does a centrally planned economy

oppose that a market economy encourages?

Explain why each of the following goals is difficult to achieve in a centrally planned economy:Economic freedomEconomic growth

Who benefits and who suffers most from a centrally planned economy? How?

Mixed EconomiesMost economies today are “mixed”Mixed Economy – a market-based

economic system in which the government is involved to some extentthe degree to which the government is

involved varies from nation to nation

Mixed economies

Mixed EconomiesA wide variety of Mixed Economies existEconomic Transition – a period of change

in which a nation moves from one economic system to another

Privatization – the process of selling businesses or services operated by the government to individual investorsChina is currently selling state owned

businesses to individuals and then letting them compete in the market place

Mixed EconomiesU.S. Economy

Founded on Free-Market principlesFree Enterprise System – an economic system

characterized by private or corporate ownership of capital goods

Government intervention plays a key role in economy

However, government allows marketplace to operate with minimal regulation

U.S. enjoys a high level of economic freedom

Chapter 2.4 QuestionsWhy have some nations began an

economic transition to a free enterprise system?

How does laissez faire differ from a centrally planned government?

How is China carrying out privatization?