Economic Systems

Chapter 2: Economic Systems KEY CONCEPT An economic system is the way in which a society uses its resources to satisfy its people’s unlimited wants. WHY THE CONCEPT MATTERS An economic system determines what to produce, how to produce, and for whom to produce. Countries have mixed systems, but some systems give more economic and political freedom and create more wealth than others.

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

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

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

Types of Economic Systems TYPE 3: Market Economy 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 Consumers, producers benefit each other when they act in self-interest

Characteristics of Traditional Economies KEY CONCEPTS Early societies all had traditional economies Traditional systems help societies survive Tend to be inefficient; do not adapt to change

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

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

Reviewing Key Concepts Use each of the terms in a sentence: traditional economy command economy market economy

Command Economies Government Controls KEY CONCEPTS Centrally planned economy—central government makes all decisions Decides for whom to produce in part by setting wages only some people have money to buy available products

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

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

Government Controls EXAMPLE: Socialism and Communism Democratic socialism established under democratic political process government owns basic industries other industries private central planners make decisions for government-owned industries central planners might control other sectors, such as health care

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

Command Economies Today KEY CONCEPTS No pure command economies today modern telecommunications bringing about change Some economies still have mostly command elements

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

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

Reviewing Key Concepts Write a brief paragraph explaining the links between the following three terms: centrally planned economy socialism communism

Fundamentals of a Market Economy Market Economies Fundamentals of a Market Economy KEY CONCEPTS Private property rights—right to own businesses and resources Property means material objects, money, intellectual property, labor Market—place or situation where people buy and sell goods, services

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

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

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

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

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

Circular Flow in Market Economies KEY CONCEPTS Circular flow model illustrates how interactions occur in a market Represents the two key decision makers: households, businesses Shows the two markets where households and businesses meet goods and services resources

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

Circular Flow in Market Economies Factor Markets Factor market—market for the factors of production land, labor, capital, entrepreneurship Individuals own all factors of production own some outright, such as labor; some indirectly, such as stocks individuals are producers; businesses are customers

Circular Flow in Market Economies Circular flow model shows how market economies operate outside arrow shows flow of money inside arrow shows flow of resources and products

Impact of Market Economies KEY CONCEPTS Late 1940s to early 1990s, many countries had command systems U.S.S.R., Eastern Europe, China, much of SE Asia, Cuba, North Korea Most of these countries have now adopted market systems remaining communist countries using some market measures

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

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

Reviewing Key Concepts Explain the relationship between the terms in each of these pairs: private property rights and market laissez faire and capitalism specialization and profit factor market and product market

Today’s Mixed Economies Modern Economies in a Global Age Today’s Mixed Economies KEY CONCEPTS Mixed economy has elements of traditional, command, market systems most common type of economic system Traditional, command, market economies adopt elements from others

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

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

Trends in Modern Economies KEY CONCEPTS Economies change in response to natural, social, political changes East European economies changed after fall of communism

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

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

Reviewing Key Concepts Write a sentence that illustrates the meaning of each of the following terms: mixed economy Nationalize Privatize global economy

Case Study: Contrasting Economies: North Korea and South Korea Background Korea was a single country until end of World War II North Korea has communist government, command economy South Korea is democracy with market economy What’s the Issue? How effective are command and market economies? Thinking Economically Based on documents A and C, in which country does the government appear to be more involved in controlling business and the economy? Based on documents A and C, what can you infer about the effects of government activities on productivity in the two nations? In today’s global economy, is a command economy or a market economy more likely to succeed? Support your answer with information presented in the three documents.