Chapter 2 – Economic Systems Resources are scarce everywhere, thus: Every country must answer three economic questions What 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 values Every society pursue each goal to some degree: Economic Efficiency – maximize what can be produced can’t be efficient unless you can provide the right goods to the right people at the right time Economic Freedom – the opportunity for individuals to make their own choices Economic Security – people want to know that goods/services are available when needed and that they will get paid on time Safety net – governments programs like workman’s compensation, unemployment compensation, social security disability payments Economic goals and societal values Economic 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 growth Standard of Living – level of economic prosperity Innovation – process of bringing new methods, products, or ideas into use Instrumental 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 Economies Traditional Economy Oldest and simplest economic system Relies on habit, custom, or ritual to answer three economic questions Little room for innovation Revolves around a family unit Found in small, close knit communities Individuals work to support the community not themselves Ex. Native Amazon tribes, African tribes, some 3rd world nations Chapter 2.1 Questions What 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 System Market – any arrangement that allows buyers and sellers to exchange things These 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 activities This leads to the most efficient use of capital, land & labor Free Market System Free Market Economy – answers to the three economic questions are made by voluntary exchange in markets. Also known as Capitalist Economy Individuals and privately owned business own the factors of production, make what they want, and buy what they want Free Market System Factor Market – When firms purchase factors of production from households Hiring workers Renting 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 way Competition – the struggle among producers for the dollars of consumers Self interest and competition work together to regulate the marketplace Free Market System Advantages 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 Goals Consumer 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 Questions How 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 Economies Centrally Planned Economy – the government, rather than individual producers and consumers, answer the key economic questions Government owns the land and capital Government decides where people work and what they are paid Also known as a “Command Economy” Opposed to private property, free market pricing, competition and consumer choice Centrally Planned Economies Two types of government associated with Command Economies Socialism – 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 decisions Soviet Union China Centrally Planned Economies Disadvantages 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 Questions What 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 freedom Economic growth Who benefits and who suffers most from a centrally planned economy? How? Mixed Economies Most economies today are “mixed” Mixed Economy – a market-based economic system in which the government is involved to some extent the degree to which the government is involved varies from nation to nation Mixed economies Mixed Economies A wide variety of Mixed Economies exist Economic 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 investors China is currently selling state owned businesses to individuals and then letting them compete in the market place Mixed Economies U.S. Economy Founded on Free-Market principles Free 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 Questions Why 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?