Economic Systems Chapter 2 Economic Systems All societies

Economic Systems Chapter 2

Economic Systems All societies have an economic system or a way of providing for the wants and needs of their people. � An Economic Systems function is to produce and distribute goods and services to consumers �

Economic System An economy must answer 3 economic questions: What should be produced? How should it be produced? Who will consume these goods and service?

Economic Systems � How a society answers these questions depends on how much it values economic goals of efficiency, freedom, security, equity and growth.

3 Key Economic Questions What goods or services should be produced? -How much resources should be devoted to national defense? Education? Health care? 1)

3 Key Economic Questions 2) How should it be produced? � -Should we have coal, oil, or nuclear power? Should teacher have 20 kids or 50 kids in a room?

3 KEY ECONOMIC QUESTIONS Who consumes the goods and services? - How will society distribute income? Who will buy the household products? Who will clean your house? 3)

Types of Economies � Traditional economy: Relies on habit or custom. Little innovation. Similar to family system. Boys follow dad’s footsteps, girls follow mom. Examples: Hunting, farming. Low standard of living.

Types of economies Market economy: Decisions made by individuals based on exchange, trade. (aka free markets, capitalism)

Types of Economies Centrally planned economy: (aka command economy) Government decides everything. Example: communism.

Types of Economies � Mixed economy: Market-based economy where government plays a limited role. This is the United States.

Traditional Economy � Allocation of scarce resources, and nearly all other economic activity, stems from ritual, habit or custom. � Individuals are not free to make own decisions. � Advantage: everyone knows the role they play � Disadvantage: discourages new ideas

Market Economy � People and firms make decisions based on what best suits their interest. Ex. USA, Canada and Great Britain � Advantage: overtime it can make changes in demand. Ex. Fast food to health food � Disadvantage: does not always provide for basic needs of people. Ex. Homeless people

Circular Flow

Command Economy A central authority (government) makes most of the decisions. � People have little if any influence over production. Ex. North Korea, Cuba and former Soviet Union. � Advantage: can change direction drastically in a short time. Ex. farming to industrial � Disadvantage: Not designed to meet the wants of consumers (Everyone gets only 1 In and Out burger. �

Chapter 2 Section 2

The Free Market � Market: An arrangement that allows buyers and sellers to exchange things. � Markets exist because it allows people to buy what they need to consume and sell goods and services they produce.

The Free Market � Specialization: The concentration of the productive efforts of individuals and firms on a limited number of activities. � Example: a mechanic specialized in fixing Japanese cars or and assembly line

The Free Market � Household: A person or group of people living in the same residence. � Firm: Business; an organization that uses resources to produce a product � Factor market: Market in which firms purchase the factors of production (land, labor, capital) from households

The Free Market Profit: The financial gain made in a transaction Product market: The market in which households purchase the goods and services that firms produce.

The Free Market � Free market is an economic system where people do what’s best for them for personal gain. � Consumers have an interest in looking for lower prices � Producers engage in a competition for consumer’s money.

Adam Smith (1723 -1790) Wrote The Wealth of Nations in 1776 � Known as the Father of Economics � Said people are selfish, but that’s ok because it works � Called the relationship between self interest and competition the invisible hand � Said government should stay out of the economy (laissez faire means ‘hands off’) � Government should only be involved with education, health care and transportation. �

Adam Smith Assignment � In your notebooks, you will create a graphic organizer on the left side of the Adam Smith article you are about to read

Circular Flow

The Free Market Self-interest is the motivating force behind the free-market. People produce goods and services for their own personal gain. � Competition is the struggle among producers for the dollars of consumers. This helps control firm’s selfishness. � Competition act’s as a regulating force in the marketplace. Without competition a business can monopolize a product or service �

The Invisible Hand (self interest and competition) � rewards efficient producers and buyers � results in: � goods society wants � quantity society wants � prices society is willing and able to pay � normal profits

The Free Market � The Free Market Economy, however, does need some Government intervention to provide for things that the market place does not address. � Example: national defense, roads and highways, education, and health care � Incentive: The hope of reward or the fear of punishment that encourages people to act in a certain way.

The Free Market � Why is the free market system good? � 1) It works. Producers make what consumers want, when they want it. Prices are pretty good. � 2) Freedom. Work where you want, buy what you want, make what you want.

The Free Market � 3) Growth is encouraged because innovation is encouraged. � 4) A wide variety of things get made because consumers decide what gets made.

The Free Market � Consumer sovereignty is the power of consumers to decide what gets produced

Why the Market? Scarcity exists � Societies must find a way to allocate scarce goods and services � In any allocative mechanism, some people will be told “No. ” � The market system is efficient, but… � Neither markets nor other economic systems are “fair. ” �

Chapter 2 Section 3

Centrally Planned Economies In command economies, the government controls the factors of production and answers the 3 economic questions of what, how and for whom to produce for all of society. � Idea is that the government makes all the choices that will benefit or is best for the whole society, not just a few individuals � Command economies often associated with socialism, communism and authoritarianism. �

Centrally Planned Economies � Socialism is the belief that democratic means should be used to distribute wealth evenly through a society � Communism is the belief that government leaders should distribute wealth evenly through a society. � Authoritarianism (Fascism)- requiring strict obedience to an authority, such as a dictator. No individual freedoms.

Centrally Planned Economies Problems � Poor Quality of Goods= workers don’t care, as long as they produce what they are told to produce � Shortages of Goods and Services= need products are not made � Diminishing Production = workers don’t care, they don’t get raises for producing more; no incentives � Performance always falls short of ideals that the system is built � Can’t meet the needs of consumers needs and wants: Government decides what is produced, not consumers � The system does not reward innovation, is not flexible, and sacrifices individual freedoms for the “good” of whole society