Topic 2: Free Enterprise and Other Economic Systems

Topic Objectives Students will be able to Identify the three basic economic questions that all societies must answer Describe the economic goals that determine how a society answers the three economic questions. Define the characteristics of a traditional society. Explain why markets exist. Explain a circular flow model of a free market economy. Describe how self-interest and competition lead to the self-regulating nature of the  marketplace. Identify the advantages of a free market economy. Describe how a centrally planned economy is organized, including its disadvantages. Distinguish b/w socialism and communism. Explain the rise of mixed economic systems. Explain the basic characteristics of the US free enterprise system. Describe the role of government in the US free enterprise system.

I. The Three Basic Economic Questions Because resources are scarce, every society must answer three economic questions: What goods/services should be produced? How should these goods/services be produced? Who consumes these goods/services? The way a society answers these questions defines its economic system.

Three Questions… What Goods/ Services to Be Produced? * Every society must decide what to produce to satisfy needs/wants * Ex: food, shelter, consumer goods. * Each decision comes w/ opportunity costs How Should Goods and Services Be Produced? * Ex: What fuel use? Oil, solar, nuclear? * Figure 2.1 * All decisions involve trade-offs

Three Questions… Who Consumes the Goods and Services that are produced? * Answers to questions are largely determined by how societies distribute income. * Factor Payments * Profit

I. Three Questions… Economic Goals of Society Efficiency Freedom Security… safety net Equity… Figure 2.2 Growth… Standard of Living, Innovation Conflicting Economic Goals ***Traditional Economies Which basic economic goals can be achieved easily in a traditional economy? Which cannot?

II. Free Markets Why Do Markets Exist? Define: Markets * Markets eliminate the need for self-sufficient Role of Specialization * Leads to efficiency in the use of capital, land, and labor; benefits businesses and specialists Buying and Selling * Need a mechanism that allows buying/selling that was produced and buy what they want.

II. Free Markets Elements of a free Market Economy Answers to the 3 ?s are made by voluntary exchange in markets. Individuals and businesses make their own decisions about what to buy or sell. Mkt Eco: sometimes called capitalist economies b/c the capital that entrepreneurs invest is a vital part of system. Role of Households/ Firms: Role of Factor & Product Markets:

II. Free Markets How Markets Self-Regulate Self Interest & Adam Smith/ The Wealth of Nations Incentives & Competition Figure 2.5 The Invisible Hand What does competition among producers in a free market accomplish for consumers?

II. Free Markets Advantages of a Free Market Economic Efficiency Economic Freedom Economic Growth Additional Goals Note: Figure 2.6 Consumer Sovereignty

III. Centrally Planned Economies Features of Central Planning Definition Govt answers 3 ?s; owns land, capital, even labor Contrast to a free market system No free mkt forces of self-interest, incentives, and competition. Communism and socialism are two examples of central planned economies.

III. Centrally Planned Economies Socialism Range of eco systems/ practices Allows ownership of some private property Can be part of democratic system Communism Requires revolutionary change Govt is authoritarian, not democratic State ownership of f of prod

III. Centrally Planned Eco: Socialism v. Communism Both: even distribution of wealth and centralized control of economic power. Note: Authoritarian, Karl Marx Why does communism require an authoritarian govt? What belief did Karl Marx hold about capitalism? Figure 2.8: Production Goals: Soviet 5 Year Plan

III. Centrally Planned Economies Disadvantages of Central Planning Economic Inefficiency Lack of Economic Freedom Lack of Economic Growth Economic Inequity Additional Goals Why do centrally planned economies tend not to be efficient? Who benefits and who suffers most from a centrally planned economy? How?

IV. Mixed Economies The Reasons for a Mixed Economy A. Why Govt Gets Involved *5 Reasons B. Balancing Govt and Eco Freedom

IV. Mixed Economies II. Circular Flow Model of a Mixed Economy

IV. Mixed Economies… Circular Flow Govt Actions in the Factor Market Govt Actions in the Product Market Govt Actions Transferring Money

IV. Mixed Economies Mixed Economies Today 1. Mixed Eco w/ Heavy Govt Involvement 2. Mixed Eco Tending Toward Free Markets 3. Role of Govt 4. Overall Economic Freedom Note: Continuum on Mixed Economies: Figure 2.12

V. Benefits of Free Enterprise A. Basic Characteristics of Free Enterprise 1. Opportunity 2. Incentives 3. Profit Motive 4. Competition; Open Opportunity 5. Legal Equality 6. Private Property Rights 7. Economic Freedom: Free contract, voluntary exchange

V. Benefits of Free Enterprise Key Roles in the Free Enterprise System 1. Role of the Consumer: interest group 2. Role of the Entrepreneur Economic Freedom and the Constitution 1. Property Rights: eminent domain; 5th A 2. Taxation: 16th A 3. Contracts

V. Benefits D. Limited Role of Govt in the Marketplace ** Constitutional responsibility to protect property rights evolved into actions to promote the public interest. Information & Free Enterprise: public disclosure laws Protecting Public Health, Safety, and Well-being Negative Effects of Regulation Figure 2.15: Major Regulatory Agencies How would the right of voluntary exchange be undermined if Congress overturned all public disclosure laws regarding the car industry?

Important Terms Macroeconomics: study of economic behavior and decision-making in a nation’s whole economy. Microeconomics: study of economic behavior and decision making in small units (households, firms) Gross Domestic Product: total value of all final goods and services produced annually in a country. Business Cycle: the alternating pattern of periodic expansion and contraction (Figure 2.6) Public Good: shared good or service (infrastructure); financed by the public sector.

Enduring Objectives Because societies answer the key economic questions differently, multiple economic systems have developed. Competition helps to regulate markets and gives producers incentives to make what consumers want. Because pure market and pure centrally planned economies have drawbacks, nations tend to have mixed economies. Under the American free enterprise system, the government preserves economic freedoms while protecting the public interest through limited regulation of the economy.