© 2007 Thomson South-Western

Economic Systems

What is an Economic System? It’s the method used by society to produce goods and services

The Four Economic Systems Traditional Economy Market Economy Planned/Command Economy Mixed Economy

Traditional Economy Relies on habit, custom, or ritual to make economic decision

Market Economy Private consumers and producers make the economic decisions No government involvement

Planned/Command Economy The government makes all of the economic decisions “We’ll fulfill five-year plan in four years!”

Mixed Economy Economic decisions are made by both the government and private consumers/producers.

Economic Models

Two of the most basic economic models are: Economists use models to simplify reality in order to improve our understanding of the world. Two of the most basic economic models are: The Circular Flow Diagram The Production Possibilities Frontier

Our First Model: The Circular-Flow Diagram The circular-flow diagram is a visual model of the economy that shows how dollars and resources flow through markets among households and firms. 6

Figure 1 The Circular Flow Model Firms sell Households buy MARKETS FOR GOODS AND SERVICES Spending Revenue Goods and services received Produced goods and services FIRMS HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Labor, land, and capital Factors of production Wages, rent, and profit Income = Flow of inputs and outputs = Flow of dollars

Our Second Model: The Production Possibilities Frontier The production possibilities frontier is a graph that shows the combinations of output that the economy can produce given the available factors of production (resources). 14

The Production Possibilities Frontier Quantity of Computers If all resources were used, you can make 3,000 computers and 0 Cars. Or, you can make 1,000 cars and 0 computers The PPF shows you the maximum amount of resources you have for production Produced 3,000 A 2,200 600 Production Possibilities Frontier Quantity of 1,000 Cars Produced

The Production Possibilities Frontier Quantity of A= B= C= D= E= Production Efficiency Computers Produced Production Efficiency C Not possible! Underutilization 3,000 Efficiency & specialization in car production A 2,200 600 B 700 2,000 D 1,000 300 E Brain Busta!!! Quantity of 1,000 Cars Produced

Our Second Model: The Production Possibilities Frontier Concepts illustrated by the production possibilities frontier Allocation of resources Opportunity cost Economic growth 21

What can cause the PPF to shift? PPF Questions… Quantity of Computers What is the opportunity cost of moving production from point A to point B? What is the opportunity cost of moving production from point D to point B? Produced 3,000 What can cause the PPF to shift? A 2,200 600 B 700 2,000 D 1,000 300 Quantity of 1,000 Cars Produced

A Shift in the Production Possibilities Frontier Quantity of Computers Produced Something changed that caused there to be more resources in computer production. What do you think would cause the PPF to shift this particular way? 4,000 3,000 1,000 2,300 650 G 2,200 600 A Quantity of Cars Produced