1. Chapter 2 Economic Systems

2. Three Key Economic Questions What goods and services should be produced? How should these goods and services be produced? Who consumes these goods and services? In order to answer these questions, one must know what an economic system is….

3. What are Economic Systems? An economic system is the structure of methods and principles a society uses to produce and distribute goods and services. Lets go back to the key economic questions….

4. What goods and services should be produced? Society needs to decide what to produce in order to satisfy the needs and wants of its people. While all people need food and shelter, societies face additional important considerations of what consumer goods to produce. They must figure out, since resources are scarce, how their society wants to allocate those resources – do you devote a lot of your economic system to national defense, education, consumer goods? Every decision a society makes comes with an opportunity cost.

5. How should goods and services be produced? A society must also decide how to produce goods and services – What fuel should be used to generate electricity – oil, solar power, or nuclear power? Should education be delivered through public school or private schools? Production decisions comes down to the factors of production – land, labor, and capital. It also involved many trade-offs. Example: You have an farmer working 40 hours to harvest one crop where you could also use him for 40 hours to work an assembly line.

7. Who consumes goods and services? Societies must also make decisions that determine how goods and services are consumed How can people meet their needs for food and medical care? Who gets to drive a new luxury sports care and who can only afford a bus fare? Who gets access to college education? The answers to those questions is largely determined by how societies distribute income – Factor payments are the income people receive in return for supplying factors of production – land, labor or capital. Landowners collect rent, workers earn wages, and those who lend money receive payments called interest. Factor payments can also include profits made by that of entrepreneurs. Profit is defined as the amount of money a business receives in excess of its expenses The answer to who consumes goods and services tells a great deal about a society’s values.

9. Economic Goals and Societal Values Different societies answer the three economic questions based on the importance they attach to various economic goals The goals include efficiency, freedom, security, equity, and growth

10. Economic Efficiency Because resources are always scare, societies try to maximize what they can produce using the resources they have. Reducing the amount of waste is a good way a society can produce more goods An economy that cannot deliver the right goods in the right quantity to the right people at the right price is not efficient

11. Economic Freedom Most people value the opportunity to make their own choices. Still, people all over the world face limitations on their economic freedom

12. Economic Security We want to know that we can get milk or bread every time we go to the grocery store – economic systems seek to reassure people that goods and services will be available when needed and that they can count on receiving expected payments on time. Many governments provide a safety net, or set of programs to protect people who face unfavorable economic conditions such as layoffs, injuries, or natural disasters. Most modern nations also provide some level of base income for retired persons to ensure that they can support themselves.

14. Economic Equity Equity, or fairness, is another economic goal that is defined differently in different societies. Each society needs to figure out how to divide its economic pie. Should everyone get the same share of the goods or services a nation produces? How much should society provide for those who are unable or unwilling to produce?

15. Economic Growth A nation’s economy must grow with its population so it can provide jobs for the new people joining the workforce. A nation’s economy must grow if people are going to have more income. When that occurs, the nation improves its standard of living, or level of economic prosperity Innovation plays a huge role in economic growth. Innovation is the process of bringing new methods, products, or ideas into use. Example: Industrial Revolution – Bessemer Process

16. Goals in Conflict A society may value other goals than these. Environmental protection, full employment, or protecting national industries may be among a nation’s chief economic goals. Sometimes, economic goals can conflict with one another. Examples: A nation provides a safety net for all citizens, the added cost may slow economic growth. – To protect the environment, a government may impose regulations on manufacturers which curb economic freedom Each choice comes with some kind of trade-off

17. Specific Types of Economic Systems There are 4 types of economic systems Traditional Free Market Centrally Planned Mixed The last three are dominating the modern world

18. Traditional Economies The oldest and simplest of all economic systems There is little room for innovation and change Revolves around the family unit – often an extended family made up of several generations – work tends to be divided among cultural lines (Boys follow their fathers, Girls their mother) Usually found in communities that tend to stay relatively small and close. – often the people work to support the entire community, rather than just themselves or their immediate families

19. Traditional Economies Agriculture and hunting practices usually lie at the center of people’s lives, laws, and religious beliefs Societies with traditional economies are economically successful if they meet their own needs but have few mechanisms to deal effectively with disaster, such as flood or drought – they are also slow to adopt new ideas and technologies and lack modern conveniences

20. The Free Market A market is any arrangement that allows buyers and sellers to exchange things – markets eliminate the need for any one person to be self-sufficient. None of us produces all we require to satisfy our needs and wants – markets allow us to exchange the things we have for the things we want Specialization is the concentration of the productive efforts of individuals and businesses on a limited number of activities - can lead to efficient use of land, labor, and capital as it is easier for a person to learn one task very well then to learn them all – limits waste People typically earn income by specializing in certain jobs

21. The Free Market In a free market economy, answers to the three economic questions are made by voluntary exchanges within the market. In a free market system, individuals and privately owned businesses own the factors of production, make what they want, and buy what they want. The participants in a free market system are the household and the firms

22. The Free Market A factor market is the arena of exchange in which firms purchase the factors of production from households The product market is the arena of exchange in which households purchase goods and services from firms

23. Self-Regulation of Free Market Adam Smith was a Scottish social philosopher, best know for his book titled Wealth of Nations Smith observed that people have their own self-interest or individual gain Competition offers incentives to consumers such as lower prices The invisible hand adds to self-regulation of the market place – as long as producers make what consumers want, they will buy it. Competition causes firms to produce more and limits their desire to raise prices.

24. Advantages to a Free Market Economic Efficiency: The self-regulation in a free market economic system responds efficiently to rapidly changing conditions. Producers provide only the goods and services Economic Freedom: Workers work where they want, firms produce what they want, and individuals consume what they want Economic Growth: Competition encourages innovation leading to the encouragement of free market growth Additional Goals: Consumer sovereignty allows consumers to have the power to decide what gets produced.

25. Centrally Planned Economies Centrally Planned Economy: the government, rather than individual producers and consumers, answers the key economic questions. A central bureaucracy decides what items to produce, how to produce them, and who gets them. The government owns both land and capital, and controls where workers work (and their wages) Another name for a centrally planned economy is a command economy

26. Socialism Socialism is not a single economic system. Rather, the term describes a range of economic and political systems based on the belief that wealth should be evenly distributed throughout society. This equity or fairness of wealth can exist only if the centers of economic power are controlled by the government or by the public as a whole, rather than by individuals or corporations.

27. Communism Under communism, the central government owns and controls all resources and means of production and makes all economic decisions Communism formed largely because of the German philosopher Karl Marx who stressed the conflict between labor and capital. He believed that labor was the source of value. Authoritarian governments that can rise in a communist state limit individual freedoms and require strict obedience from their citizens.

28. Disadvantages of Centrally Planned Economies 1. Economic efficiency: since the government fixes wages, workers lack the incentive to work faster or produce more 2. Economic freedom: command economies can destroy people’s way of life and sometimes end their life based on reform movements under an authoritarian dictator 3. Economic growth: innovation is limited which prevents growth 4. Economic equity: even though equity is the goal, government officials and people in favored careers enjoy higher incomes and access to a wider variety of higher quality goods. Ordinary people often suffer shortages and poorly made goods. 5. Additional goals: Central planning has successfully met some goals. It can guarantee jobs and income. It can also jump-start selective industries.

29. Mixed Economies Every economic system has problems. Traditional economies have little potential for growth or change. Centrally planned economies limit innovation, do not adequately meet consumer needs, and limit freedom. Even free market economies have drawbacks. Sometimes government involvement is necessary. Government may be needed for protecting property rights, making sure economic exchanges are fair, and allowing for the building of roads and schools. A mixed economy is a market-based economic system in which the government is involved to some extent.

30. Roles of the Government – Mixed Economy Government in the Factor Market The government employees people like police officers and other public service industry careers Government in the Product Market The government purchases goods and services from firms in the product market. Government offices, for example, need telephones and computers Transferring Money Governments collect taxes from both households and businesses. Governments then transfer some of this money to businesses and individuals for a variety of reasons. Examples: to save a failing industry, to provide disability for workers

31. The United States Economy While the American economy is a mixed system, the foundation of the United States economy is the free market. The government of the United States plays a substantial role in the American economy. The American government keeps order, provides vital services, and promotes the general welfare. Federal and state laws protect private property. The marketplace operates with a limited degree of government regulation.

32. The United States Economy Some Americans argue that there is a need for more government services and stricter regulation on business. Others, however, say that the government already intervenes too much in the economy. They call for relaxation of existing regulations. Laissez faire is the doctrine that the government generally should not intervene in the marketplace. Overall, the United States enjoys a high level of economic freedom. Foreign investment, free trade, and lighter restrictions than that of other countries are present in the United States.