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“Introduction to Economic Systems”Critical Questions
• What key economic questions must every society answer?
• What basic economic goals do societies have?
• What types of economic systems exist today?
What is an economic system?
The method used by a society to produce and distribute goods and
services
The Three Questions that Determine
a Societies Economic SystemBecause ALL economic resources are
scarce, every society must answer three questions:– What goods and services should
be produced? • Guns or butter?
– How should these goods and services be produced? • What combination of factor
resources should we use?– Who consumes these goods and
services?• How will income be distributed?
Economic Goals
Economic Goals
Making the most of resourcesEconomic efficiency
Freedom from government intervention in the production and distribution of goods and services
Economic freedom
Assurance a safety net will protect individuals in times of economic disaster
Economic security and predictability
Fair distribution of wealthEconomic equity
Innovation leads to economic growth, and economic growth leads to a higher standard of living.
Economic growth and innovation
Environmental protection, varietyOther goals
Economic GoalsSocieties answer the three economic questions based on their goals
and values.
An economic system is the method used by a society to produce and distribute goods and services.
Four Economic Systems
Traditional economies rely on habit, custom, or ritual to decide what to produce, how to produce it, and to whom to distribute it.
In a centrally planned economy the central government makes all decisions about the production and consumption of goods and services.
In a market economy economic decisions are made by individuals and are based on exchange, or trade.
Mixed economies are systems that combine the free market with limited government intervention.
Comparing Economic Systems
Economic System
• Traditional • Market • Centrally Planned• Mixed
Who answers the 3 ?’s
• Custom• Individuals• Central Government• Individuals with some government
involvement
Traditional System
• Agricultural and hunting societies.• There is little room for innovation
or change. • They tend to lack modern
conveniences and have a low standard of living.
• Close knit communities with focus on the family unit.
Why do markets exist? Markets exist because none of us produces
all the goods and services we require to satisfy our needs and wants.
A market is an arrangement that allows buyers and sellers to exchange goods and services.
Specialization is the concentration of the productive efforts of individuals and firms on a limited number of activities.
The Free Market System (a.k.a. Capitalism)
Free Markets
monetary flow
physical flow
monetary flow
physical flow
Circular Flow Diagram of a Market Economy
Households Firms
• In a free market economy, households and business firms use markets to exchange money and products.
• Households own the factors of production and consume goods and services.
Adam Smith (1723-90)
• Scottish social philosopher and professor• “An Inquiry into the Nature and Causes of
the Wealth of Nations” (1776)– 10 years to write – 5 volumes
• “Laissez faire” • The Invisible Hand
– Self Interest (Motivating Force)– Competition (Regulating Force)
Advantages of the Free MarketEconomic Efficiency
As a self-regulating system, a free market economy is efficient.
Economic Growth
Because competition encourages innovation, free markets encourage growth.
Economic Freedom
Free market economies have the highest degree of economic freedom of any economic system.
Additional Goals, i.e. variety
Free markets offer a wider variety of goods and services than any other economic system.
In a centrally planned economy, the government owns both land and capital. The government
decides what to produce, how much to produce, and how much to charge.
Socialism is a social and political philosophy based on the belief that democratic means should be used to distribute wealth evenly throughout a society.
Communism is a political system characterized by a centrally planned economy with all economic and political power resting in the hands of the government. Communist governments are authoritarian in nature.
Organization of Centrally Planned Economies
KARL MARX(1818-1883)
• German philosopher• Radical approach to fix the problems in free
market systems• Communist Manifesto (1848) with Frederick
Engels.• Argued that history is a series of class struggles
between the rich capitalists and the working class “proletariat”.
• He believed that eventually workers needed to unite and revolt against the capitalists. This revolution would create a classless society.
The Soviet Union• The Bolshevik
Revolution (1917)• Lead by Vladimir
Lenin• Creates a
centrally planned economy
The Soviet Experiment• Factors of production controlled by the state • Resources= armed forces, space program, capital
goods• Government committees decided the quantity,
process and distribution of products• The government created large state-owned farms
and collectives• Little incentive to produce, decline in the
production of goods.
Problems in Centrally Planned Economies
• Poor-quality goods, shortages, and diminished production
• Fail to meet consumer needs and wants
• Little individual incentives to work • Lack of innovation• Expensive and inflexible government
structure• Sacrifice of individual freedoms
Mixed Economies
• It is doubtful that any nation can exist successfully under a pure centrally planned economy or a pure market economy.
• Most economies mix features of both systems.
Continuum of Mixed Economies
Centrally planned Free market
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
Iran
North Korea
Cuba
China
Russia Greece Peru United States
South Africa France United Kingdom
Botswana Canada Singapore
Hong Kong
An economic system that permits the conduct of business with minimal government intervention is called free enterprise. The degree of government
involvement in the economy varies among nations. Nations are placed on a continuum (a range with no
clear divisions) of mixed economies. On one end are centrally planned economies and on the opposite end are free markets economies.
Comparing Mixed Economies
Tradition of Free Enterprise
The Economic Trade-off (Freedom vs. Protection): Americans have favored economic freedom over economic regulation, but we still expect the government to protect us from the problems that can exist in free markets (market failure, externalities)
Rights and Roles of the American Consumer
• Rights • Property Rights• Contracts • Taxation
• Roles• Consumer• Voter
The Role of Government1. Protect the Public Interest
2.Provide Information 3. Promote Growth and Stability
Gross Domestic Product
The main indicator used to determine overall health of the economy is gross domestic product (GDP) which is the dollar value of all final goods and services produced within a country’s borders in a given year.
This will allow them to better determine upcoming business cycles to determine prosperity, recession or depression.
Limitation of GDP• Non-market
activities• Underground
economy• Quality of lifeGDP vs. GNP
Annual income earned by US owned firms and citizens.
Types of Unemployment1. Frictional Unemployment- Occurs when people change jobs,
get laid off from their current jobs, take some time to find the right job after they finish their schooling, or take time off from working for a variety of other reasons
2. Structural Unemployment- Occurs when workers' skills do not match the jobs that are available. Technological advances are one cause of structural unemployment
3. Seasonal Unemployment- Occurs when industries slow or shut down for a season or make seasonal shifts in their production schedules
4. Cyclical Unemployment- Unemployment that rises during economic downturns and falls when the economy improves
Unemployment Rates
The Bureau of Labor Statistics determines the unemployment rate (% of the labor force that is unemployed) each period
Getting Everyone To Work!!!!
• Economists generally agree that in an economy that is working properly, an unemployment rate of around 4 to 6 percent is normal.
• Sometimes people are underemployed, that is working a job for which they are over-qualified, or working part-time when they desire full-time work.
• Discouraged workers are people who want a job, but have given up looking for one.
Full employment is the level of employment reached when there is no cyclical unemployment.
Going….UP!!!!!!!!!!
• Inflation is a general increase in prices.
• Inflation limits purchasing power (the ability to purchase goods and services).
To Market, To Market
• The consumer price index (CPI) is computed each month by the Bureau of Labor Statistics.
• This is a measure of the price of a typical consumers “market basket”.
What is in the basket?There are over two hundred categories of products that are
included in the basket. These categories fall under 8 major groups:
FOOD AND BEVERAGES
HOUSING
APPAREL
TRANSPORTATION
MEDICAL CARE
RECREATION
EDUCATION AND COMMUNICATION
OTHER GOODS AND SERVICES
What’s the big deal?The three main problems caused by inflation are:
–Reduced Purchasing Power
–Erosion of Interest Income
–Erosion of Wages/Income
The Poverty Problem
Although the free market is the most successful economic system at producing wealth—distribution is HIGHLY uneven.
The poverty threshold is an income level below what is needed to support families or households. What is the current threshold?!?!?!?!?!?!!??
POVERTY...THE FORGOTTEN STATE
Redistribution ProgramsType of Program Description Example Example
Cash Transfers Direct payment of cash to qualifying individuals
Temporary Assistance to Needy Families
Unemployment Compensation
In-Kind Benefits Goods and services for free or reduced prices
Food Stamps Subsidized housing
Medical Benefits Health insurance to those that cannot provide it for themselves
Medicare Medicaid
Education Benefits Federal, state, and local government all provide money for the poor and disabled to ensure all people receive educational opportunities.
Pell Grants Head Start