ECONOMIC SYSTEMS Ch. 2 & 3 TRADITIONAL COMMAND MARKET

The Three Basic Questions: l Doesn’t matter what type of economic system a country has, all ask the same 3 basic questions of economics: 1.WHAT TO PRODUCE? 2.HOW TO PRODUCE IT? 3.FOR WHOM TO PRODUCE?

TRADITIONAL l Allocation of scarce resources by ritual, custom, or habit, e.g. hunter-gatherer societies l An economy in which the basic economic questions are answered by custom & tradition l Individuals not free to make decisions based on what they want l Economic decisions are based on how they were made in the past l Economy is self-sufficient and mostly make things necessary to survival

TRADITIONAL l No specialization or division of labor l No real changes in technology l Producers are their own consumers l Bartering, instead of money l Examples: the Amish, Indian cultures in Central & S America

TRADITIONAL l Strengths: Everyone has defined role Little uncertainty over how, what, for whom l Weaknesses: Discourages innovation Discourages satisfaction of personal wants; tends to have lower standard of living

COMMAND l Economy controlled by the government l Government owns all factors of production (resources, factories, railroads, etc.) l Economic decisions are made by the central government – at the top & people expected to follow l State can shift resources at will to focus on new priorities l a/k/a CENTRAL PLANNING; characteristic of communist countries l Interdependent: much specialization and division of labor

COMMAND l Examples: former Soviet Union, Cuba, Iraq, early People’s Republic of China l Strengths: Planning agencies can shift resources quickly on a massive scale – WHY can this type of economy change direction so quickly? No unemployment - labor shortages solved by forcing redirection of workers

COMMAND l Weaknesses: Does not meet needs and wants of individuals Few consumer goods and very long waits Little incentive to work – low pay (“We pretend to work & they pretend to pay us)” People keep jobs for life – so no incentive to work hard Large decision-making bureaucracy – out of touch and slow Does not move quickly to solve day to day problems

MARKET ECONOMY lPlPrivately-owned capital goods are used to produce all goods and services without significant government intervention lPlPeople and companies act in own self interest to answer “What, How, For Whom” Economics decisions are based on supply & demand Markets allow buyers & sellers to come together lElEntrepreneurs! lIlInterdependent: much specialization and division of labor lHlHighest standard of living lOlOperate based on Adam Smith’s theories

Adam Smith, Wealth of Nations, 1776 l In order to have wealth, need to accumulate products that are tangible, scarce, useful, and transferable l Father of Classical Economics l Labor is more productive as workers get more skilled l Division of labor/specialization leads to increase in production and thus greater “wealth of nations” l Wealth of a nation should be defined as sum of its labor- produced goods, not who owns them (& not land) l Laissez-Faire – minimal governmental intervention l Invisible Hand – competition acts as an “invisible hand” that guides resources to their most productive uses. All people pursue selfish interests…this benefits whole society

Adam Smith’s Invisible Hand Productivity and Wealth The Circular Flow Keep The Government Out Of Our Business! Laissez-Faire Division of Labor And Specialization

MARKET l Highest production and sale of consumer goods l Examples: U.S., Canada, Japan, Great Britain… l a/k/a Capitalism & Free Enterprise l Strengths: Can adjust to change over time – gradual Change not prohibited or discouraged Decision making decentralized- resources directed to where consumers want them Huge variety of goods and services Freedom for everyone involved - people decide their own “What, How, For Whom” with relatively little government interference

MARKET l Weaknesses: People may be caught without work as the “For Whom” question is not always clear. Young and sick may not get support as they are unproductive Markets don’t always function optimally – need competition, resources free to move around, need good market information Public goods not naturally provided – why not?

U.S. ECONOMY Mixed A Modified Private Enterprise Economy Capitalism modified by government intervention and regulation So… market mixed with command. What is the current mix? What is the role of the consumer in the U.S. economy? Consumer Sovereignty – consumers rule! What is the role of government? Protector, provider & consumer, regulator, promotes national goals

l 5 CHARACTERISTICS: Economic Freedom Choices for consumers & businesses Voluntary exchange Buyers & sellers freely exchange in market transactions Private property rights Profit motive Entrepreneurs Competition Only because private individuals own the factors of production – better goods, lower price