1. © 2007 Thomson South-Western

2. Economic Systems

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

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

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

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

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

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

9. Economic Models

10. 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

11. 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

13. 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

14. 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

15. 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

16. 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

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

18. 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

19. 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