Economic Systems Chapter 2

Introduction to Economic Systems Section 1

I. Types of Economic Systems A. KEY CONCEPTS 1. Economic system—how society uses resources to satisfy people’s wants 2. Three basic systems: traditional, command, and market economies 3. Mixed economies have features of more than one type of system

B. TYPE 1: Traditional Economy 1. Traditional economy centers on families, clans, or tribes a. decisions are based on customs and beliefs 2. Everyone has a set role; no chance of deviating from pattern 3. Good of the group always comes before individual desires

C. TYPE 2: Command Economy 1. Command economy—government makes economic decisions 1.determines what to produce; how to produce; who gets products 2. Wants of individual consumers rarely considered 3. Government owns means of production: resources and factories

D. TYPE 3: Market Economy 1. Market economy driven by choices of consumers and producers consumers spend money, go into business, sell their labor as they wish producers decide how to use their resources to make the most money 2. Consumers, producers benefit each other when they act in self-interest

II. Characteristics of Traditional Economies A. TRAIT 1: Advantages and Disadvantages 1. Advantages: little disagreement over goals, roles a. methods of production, distribution determined by custom 2. Disadvantages: as result of resistance to change, less productive b. do not use new methods; people not in jobs they are best suited for c. low productivity results in low standard of living

B. TRAIT 2: Under Pressure to Change 1. Many traditional economies under pressure to change 2. Kavango people of Namibia lived as subsistence farmers for centuries 3. Modern telecommunications brought Kavango images of outside world a. thousands have moved to cities b. a few have turned to commercial farming

Discussion Questions/Review What is an economic system? List and identify three types of economic systems? Identify one positive and one negative aspect of each system. Interpret the following quote: “Political institutions are a superstructure on an economic foundation.”

BASIC ECONOMIC QUESTIONS 1. What goods and services should be produced? 2. How should the goods be produced? 3. For whom should the goods be produced?

Command Economies Section 2

I. Government Controls A. EXAMPLE: Government Planning 1. In all societies, government exerts some control over people’s lives 2. In centrally planned economy, government exerts great control a. determines businesses to operate, amount produced each month b. determines who is employed, work hours, pay scales

B. EXAMPLE: Socialism and Communism 1. Karl Marx influenced some societies to adopt command economies a. socialism—government owns some of the factors of production b. communism—no private property; little political freedom 2. Authoritarian system requires total obedience to government a. communism is authoritarian socialism

B. EXAMPLE: Socialism and Communism (Cont.) 1. Democratic socialism established under democratic political process a. government owns basic industries b. other industries private c. central planners make decisions for government-owned industries d. central planners might control other sectors, such as health care

II. Karl Marx: Economic Revolutionary A. A New View of Economics 1. Marx lived during Industrial Revolution 2. Argued factory owners used workers as resource a. exploited workers by keeping wages low to increase profits b. workers would rebel, establish classless society 3. Wrote The Communist Manifesto (with Friedrich Engels), Das Kapital (Capital)

III. Command Economies Today A. North Korea 1. Communist North Korea used resources for military, not necessities a. built large army; nuclear weapons program b. In 1990s and early 2000s, millions died of hunger, malnutrition c. In 1990s, production decreased and economy shrank d. Since 2003, some market activity allowed

B. Impact of Command Economies 1. In theory, command systems fair to everyone; In practice, many disadvantages a. central planners do not understand local conditions b. workers have little motivation to be productive or conserve resources c. artificially low prices lead to shortages d. people sacrificed to carry out centrally planned policies

Market Economies Section 3

I. Fundamentals of a Market Economy A. FEATURE 1: Private Property and Markets 1. Private property rights must be defined and protected by law 2. Buyers must be sure sellers have right to sell products they offer 3. Sellers must be sure they will be paid for their products

B. FEATURE 2: Limited Government Involvement 1. Laissez faire—government should not interfere in economy 2. Capitalism—system having private ownership of factors of production a. says producers will create products consumers demand 3. Actual market economies all have some government involvement

C. FEATURE 3: Voluntary Exchange in Markets 1. Voluntary exchange—traders believe they get more than they give up 2. In market economy, most trade is exchange of product for money 3. Profit—financial gain from business transaction

D. FEATURE 4: Competition and Consumer Sovereignty 1. Competition—sellers’ efforts to get business by offering best deal 2. Consumer sovereignty—buyers choose products, control what is produced 3. Competition controls self-interested behavior sellers offer low price or high value to please consumers, make profit

E. FEATURE 5: Specialization and Markets 1. Specialization—people concentrate their efforts in the activities they do best a. encourages efficient use of resources b. leads to higher-quality, lower-priced products

Ranking Rank the fundamentals of a Market Economy. For each provide an explanation for their position.

II. Circular Flow in Market Economies A. Product Markets 1. Product market—market where goods and services bought and sold a. includes all purchases by individuals from businesses

B. Factor Markets 1. Factor market—market for the factors of production a. land, labor, capital, entrepreneurship 2. Individuals own all factors of production a. own some outright, such as labor; some indirectly, such as stocks b. individuals are producers; businesses are customers

C. Circular Flow 1. Circular flow model shows how market economies operate a. outside arrow shows flow of money b. inside arrow shows flow of resources and products

III. Impact of Market Economies A. Advantages 1. Individuals free to make economic choices, pursue own work interests 2. Less government control means political freedom, less bureaucracy 3. Locally made decisions mean better use of resources, productivity 4. Profit motive ensures resources used efficiently, rewards hard work a. resulting competition leads to higher-quality, more diverse products

B. Disadvantages 1. Pure market economy has no way to provide public goods and services 2. Does not give security to sick or aged 3. During U.S. industrial boom, business owners rich, workers low pay 4. Businesses did not address problems caused by industrialization 5. Industrialized societies adopt some government control of economy

Modern Economies in a Global Age Section 4

I. Today’s Mixed Economies A. Life in a Mixed Economy 1. Family farming in U.S. serves as example of mixed economy a. traditional: all members of family help bring in harvest b. command: affected by government—public school, roads, Social Security c. market: own land, sell their products in competitive market

B. Types of Mixed Economies 1. Most economies emphasize one type; U.S. basically has market system 2. Many European countries greater mix of market and command elements a. France—government controls some industries; provides social services b. Sweden—state owns part of all companies; lifelong benefits, high taxes c. Namibia—traditional; state supports market, foreign investment

II.Trends in Modern Economies A. TREND 1: Changes in Ownership 1. Economies in transition often go through changes in ownership 2. To nationalize is to change from private to government ownership 3. To privatize is to change from government to private ownership

B. TREND 2: Increasing Global Ties 1. Growth of global economy—economic actions across national boundaries a. recent agreements open up world markets to trade among countries b. fast, safe, cheap transport of resources, products eases distribution c. phone, computer links make financial transactions quick, inexpensive d. cross-border business partnerships lower research, production costs