Comparative Economic Systems

The Three Economic Questions Every society must answer three questions: The Three Economic Questions What goods and services should be produced? How should these goods and services be produced? Who consumes these goods and services? The way these questions are answered determines the economic system An economic system is the method used by a society to produce and distribute goods and services.

Centrally-Planned (Command) Economy Free Market Economy Mixed Economy Economic Systems Centrally-Planned (Command) Economy Free Market Economy Mixed Economy

Centrally-Planned Economies (aka Communism)

Centrally Planned Economies In a centrally planned economy (communism) the government… owns all the resources. decides what to produce, how much to produce, and who will receive it. Examples: Cuba, North Korea, former Soviet Union, and China? Why do centrally planned economies face problems of poor-quality goods, shortages, and unhappy citizens? NO PROFIT MEANS NO INCENTIVE TO W!!

Characteristics of Communist Economies

China and Other Communist Nations Cuba Fidel Castro led a revolution in Cuba in 1959 to overthrow a corrupt government. In 1961, Castro declared himself a Marxist and the country became communist in nature. Asia North Korea is one of the few remaining communist countries in the world. Communism also spread in the Southeast Asian countries of Vietnam, Laos, and Cambodia during the mid-1970s. China When Mao Zedong took control of China in 1949, the country developed its own version of central planning. The Chinese economy today, however, has evolved into a mix of state-controlled enterprises and a growing class of private enterprises.

Advantages and Disadvantages What is GOOD about Communism? What is BAD about Communism? Low unemployment-everyone has a job Great Job Security-the government doesn’t go out of business Equal incomes means no extremely poor people Free Health Care No incentive to work harder No incentive to innovate or come up with good ideas No Competition keeps quality of goods poor. Corrupt leaders Few individual freedoms

Advantages/disadvantages of Communism What do you think are some advantages and disadvantages of Communism? Adv: Theoretically no social classes Whole country works together Everyone gets an equal amount of wealth and resources Disadv: Absolutely NO MOTIVATION to work hard No private ownership Gov’t controls wages/prices Often times becomes a dictatorship and the economy eventually collapses Not enough resources for everyone to get an equal share—Shortages

Free Market System (aka Capitalism)

Characteristics of Free Market Little government involvement in the economy. (Laissez Faire = Let it be) Individuals OWN resources and answer the three economic questions. The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently. Wide variety of goods available to consumers. Competition and Self-Interest work together to regulate the economy (keep prices down and quality up).

Right to own private property is unlimited Most industry is owned by private individuals Competition and profit are not regulated by the government

Example of Free Market Example of how the free market regulates itself: If consumers want computers and only one company is making them… Other businesses have the INCENTIVE to start making computers to earn PROFIT. This leads to more COMPETITION…. Which means lower prices, better quality, and more product variety. We produce the goods and services that society wants because “resources follow profits”. The End Result: Most efficient production of the goods that consumers want, produced at the lowest prices and the highest quality.

Example of Communism Example of why communism failed: If consumers want computers and only one company is making them… Other businesses CANNOT start making computers. There is NO COMPETITION…. Which means higher prices, lower quality, and less product variety. More computers will not be made until the government decides to create a new factory. The End Result: There is a shortage of goods that consumers want, produced at the highest prices and the lowest quality.

The Invisible Hand The concept that society’s goals will be met as individuals seek their own self-interest. Example: Society wants fuel efficient cars… Profit seeking producers will make more. Competition between firms results in low prices, high quality, and greater efficiency. The government doesn’t need to get involved since the needs of society are automatically met. Competition and self-interest act as an invisible hand that regulates the free market.

Mixed Economy--An economy in which private enterprise and governmental participation coexist U.S.- Individuals own businesses/corporations Government prohibits trusts/monopolies, operates public education, the US postal service, sets minimum wages, etc.

What do you think are some advantages and disadvantages of Capitalism?

Advantages/Disadvantages of Capitalism CHOICE Competition Opportunity for profit Plenty of incentive to work hard and improve products Disadv: RISK Possibility of Monopolies (Prices set by businesses) Economy fluctuates Large Businesses dominate small ones

Communism in the Long Run Free Markets in the Long Run Connection to the PPC Communism in the Long Run Free Markets in the Long Run CURRENT CURVE FUTURE CURVE Capital Goods Capital Goods FUTURE CURVE CURRENT CURVE Consumer goods Consumer goods Cuba Puerto Rico

What are the factors of production? How can we describe the free enterprise system and the laissez-faire theory? What is the role of government in a mixed economy? How are business organizations classified? What role do profit and loss have in a free enterprise system?

Factors of production Land One factor of production is land, which in economic terms includes all natural resources. Labor Labor is the work done by men and women to produce goods and services. Capital Capital includes all the human-made resources that are used to produce goods and services. Someone who owns capital and puts it to productive use is called a capitalist. TEntrepreneurRoleof the Entrepreneur An entrepreneur is an individual with the drive and ambition to combine land, labor, and capital resources to produce goods or offer services.

Free Enterprise System The free enterprise system is an economic system characterized by private or corporate ownership of capital goods and investments that are determined by private decision rather than by state control.

Laissez-Faire Theory and Mixed Economies Laissez-faire theory holds that government should play a very limited, hands-off role in society. The proper role of government in economic affairs should be restricted to functions intended to promote and protect the free play of competition and the operation of the laws of supply and demand. A Mixed Economy Economists usually describe an economy in which private enterprise and governmental participation coexist as a mixed economy. The American economy is a mixed economy. Government at all levels in American society has some influence on the economy.

Types of Business Organizations Sole Proprietorships Businesses owned by a single individual are sole proprietorships. Partnerships Businesses owned by two or more individuals, called partners, are partnerships. A corporation has many owners, called shareholders. A share is a fraction of ownership in the corporation. Corporations have the advantage of being able to draw from large pools of investor capital, but also have the disadvantage of having their earnings taxed twice.

Profit and Loss Profit is the amount of money you earn from the business once costs incurred running the business have been subtracted. If earnings are less than the costs, the business has not made a profit; instead, it has taken a loss. Taking risks and making investments are an essential part of the capitalist system.

Socialism What is socialism? What are some important characteristics of socialist economies? How can we describe socialism in developing countries? What are the pros and cons of socialism?

What is Socialism? Socialism – the economic and political philosophy that wealth should be fairly distributed through a society. Public ownership of the factors of production Politically they may be democratic; economically they depend on the government doing the centralized planning. Reject individualism and competition for profit that underlies the capitalist system. Instead, they emphasize cooperation and social responsibility.

The Industrial Revolution Most of current socialism began in the 19th century with the spread of the Industrial Revolution. Many people upset by the 16 hour days in unsafe conditions for low pay, with small children working alongside parents. Living conditions of workers poor. Karl Marx (1818-1883) is the father of modern socialism and was the most significant critic of capitalism during the 19th century.

Socialists and Communists Communists believe that socialism can only occur by revolution Socialists believe that socialism can occur peacefully through the democratic process.

Characteristics of Socialist Economies Nationalization – placing businesses under government control. Some countries, like England, pay the former owners a fair price. Others take over without giving any compensation to the owners. Rarely do socialist countries nationalize all businesses. They usually pick sectors with lots of workers or a few dominant companies, like utilities, transportation, steel. Others remain in private hands. Many socialist governments want the workers to control the businesses. Sweden’s Social Democratic Party wants to transfer ownership of private companies to their workers. Public Welfare – providing for equal distribution of necessities and services, such as inexpensive health care, retirement pensions, free university education, housing for the poor. Countries that provide these services at little or no cost to the users are often called welfare states. People who lose their jobs or are unable to work often receive gov’t payments almost as high as their prior salaries. All people above retirement age receive gov’t pensions. Workers in Europe receive paid maternity leave and many weeks of paid vacation each year.

Taxation – in socialist countries, because of the cost of public welfare programs, taxes are generally higher than in capitalist countries, sometimes taking 50-60% of a person’s income. Graduated tax (?) so that it may be 90% of a wealthy person’s income. Centrally Planned Economy – government bureaucrats decide how an economy will develop over a given number of years. Set targets for production and direct investments into specific industries. Also called a command economy. Most modern countries have mixed economies. There is a range of being closer to a free market or closer to a socialist economy.

Socialism in Developing Countries Socialism is very popular in developing countries No tradition of locally or individually controlled industry – starting from scratch at trying to build industry Large industries often owned by foreign companies – by nationalizing them and putting local people in charge, leaders can get broad support If a leader wants to direct the economic efforts of a nation behind certain industries, easier to do if socialist than capitalist. Sometimes leaders ignore production of basic needs like food and consumer goods. This can cause unrest and political instability, which leads some governments to turn to authoritarian methods. Few developing countries have succeeded in implementing democratic versions of socialism found in the industrial world.

Pros and Cons of Socialism Fair to supply everyone basic needs like medical care Evens out inequalities that exist in capitalism Makes political democracy work better because there is economic democracy Gives workers and ordinary citizens more control over their lives – companies could not just close without consideration of the workers and community in the area. Cons Bureaucracy complicates decision making and cannot act quickly to take advantage of new technologies Invisible hand of market place is more efficient than the visible hand of central planning Individuals have less incentive to work harder because so much of their income is taken by the government and their basic needs are provided for anyway.

Advantages/Disadvantages of Socialism Everyone is closer to ECONOMIC EQUALITY Poverty is almost eliminated Resources go where they are most needed Disadv: High Taxes Less Incentive to work hard/improve No Competition within major industries Resources can be limited thus causing shortages