U.S. Economic System Helen Naughton Department of Economics University of Montana

Economics Economy—in Greek “Household management” Economy—in Greek “Household management” Microeconomics—study of household and firm decisions Microeconomics—study of household and firm decisions Macroeconomics—study of country-level indicators (government interest rates, unemployment) Macroeconomics—study of country-level indicators (government interest rates, unemployment)

The Economic Questions 1.What goods and services are produced? 2.Which resources are used in production? 3.Who gets to consume the goods and services?

Economic System The system for answering The Economic Questions: The system for answering The Economic Questions: Does the government choose what and how much is produced or is it market-driven? Does the government choose what and how much is produced or is it market-driven? Who decides which resources are used? Who decides which resources are used? Who decides how goods are distributed? Who decides how goods are distributed?

Traditional System Economic decisions based on customs and beliefs handed down through generations Economic decisions based on customs and beliefs handed down through generations

Command System The economic system where government answers most of The Economic Questions for its people. The economic system where government answers most of The Economic Questions for its people. Former Soviet Union Former Soviet Union North Korea North Korea

Business in a Command System The government answers The Economic Questions: The government answers The Economic Questions: The government determines what inputs to use The government determines what inputs to use The government determines the quality of inputs The government determines the quality of inputs The government sets employees wages The government sets employees wages The government sets business hours The government sets business hours

Market System The economic system where markets are allowed to operate freely: The economic system where markets are allowed to operate freely: Goods and services are produced if people are willing to pay for them in the market. Goods and services are produced if people are willing to pay for them in the market. Input markets drive which resources are used in production. Input markets drive which resources are used in production. Those who are willing to pay for the goods and services receive them. Those who are willing to pay for the goods and services receive them.

Business in a Market System I answer The Economic Questions: I answer The Economic Questions: I determine what inputs to use I determine what inputs to use I determine the quality of my inputs I determine the quality of my inputs I set my employees wages I set my employees wages I set my business hours I set my business hours

US Economic System A little bit of each—MIXED SYSTEM! A little bit of each—MIXED SYSTEM! Some markets are allowed to operate freely. Some markets are allowed to operate freely. Some production and allocation decisions are made by the government. Some production and allocation decisions are made by the government. Some economic decisions are made based on tradition. Some economic decisions are made based on tradition.

Business in a Mixed System I and the government answer The Economic Questions: I and the government answer The Economic Questions: I determine what inputs to use I determine what inputs to use The government determines the quality of my inputs The government determines the quality of my inputs Minimum standards for food safety and other health hazards (no lead in paint or gasoline). Minimum standards for food safety and other health hazards (no lead in paint or gasoline). I set my employees wages I set my employees wages The government sets the minimum wage The government sets the minimum wage I set my business hours I set my business hours The government decides if I am safe to operate The government decides if I am safe to operate

Traditional System Command System Market System US North Korea Natives/A borigines

Economic Systems Across Countries It is reasonable to state that US is more market- based system than most countries overall. It is reasonable to state that US is more market- based system than most countries overall. Yet, we could likely find specific markets where the US government interferes more than other governments. Yet, we could likely find specific markets where the US government interferes more than other governments. For example, the US government has a tradition of offering support to US steel workers to protect the industry jobs and income. For example, the US government has a tradition of offering support to US steel workers to protect the industry jobs and income.

Why has the US (mostly) embraced the market economy? To promote efficiency To promote efficiency To make the economic benefit/pie as big as possible To make the economic benefit/pie as big as possible To minimize waste To minimize waste

Why not operate fully on the market system? Markets do not ensure that goods and services are allocated fairly (or that everyone gets enough to eat). Markets do not ensure that goods and services are allocated fairly (or that everyone gets enough to eat). Costs and benefits of the goods and services may be external to the market. Costs and benefits of the goods and services may be external to the market. A person who does not pay for fireworks can easily enjoy the fireworks. (External benefits) A person who does not pay for fireworks can easily enjoy the fireworks. (External benefits) A person who does not use a car can get sick from pollution emitted by cars. (External costs) A person who does not use a car can get sick from pollution emitted by cars. (External costs)

Government’s Roles 1. Increase equity Tax income and wealth Tax income and wealth Provide goods and services to the poor Provide goods and services to the poor

Government’s Roles 2. Provide goods with external benefits (private markets underprovide these goods) National security National security Infrastructure (roads and bridges) Infrastructure (roads and bridges) Educated and healthy citizenry Educated and healthy citizenry

Government’s Roles 3. Regulate goods with external costs (private markets overproduce these goods) Ensure copper mining pays for all costs (including the cost of polluted water in the river) Ensure copper mining pays for all costs (including the cost of polluted water in the river) Control hazardous waste disposal Control hazardous waste disposal Charge gasoline taxes to help pay for the external cost of air pollution from cars Charge gasoline taxes to help pay for the external cost of air pollution from cars

Balancing Roles of the Market and the Government Hotly debated in the US political system Hotly debated in the US political system Problems with finding the balance: Problems with finding the balance: External costs and benefits are difficult to measure. External costs and benefits are difficult to measure. While redistributing income may reduce inequality, it also lowers incentives for work (some argue especially for the highly productive). While redistributing income may reduce inequality, it also lowers incentives for work (some argue especially for the highly productive).

Traditional System Command System Market System

Thank you!