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Economic Systems
Chapter 2: Economic Systems
KEY CONCEPT
An economic system is the way in which a
society uses its resources to satisfy its
people’s unlimited wants.
WHY THE CONCEPT MATTERS
An economic system determines what to
produce, how to produce, and for whom to
produce. Countries have mixed systems, but
some systems give more economic and
political freedom and create more wealth than others.
Types of Economic Systems
KEY CONCEPTS
Economic system—how society uses
resources to satisfy people’s wants
Three basic systems: traditional, command,
and market economies
Mixed economies have features of more
than one type of system
Introduction to Economic Systems
Types of Economic Systems
TYPE 1: Traditional Economy
Traditional economy centers on families,
clans, or tribes
decisions are based on customs and
beliefs
Everyone has a set role; no chance of
deviating from pattern
Good of the group always comes before
individual desires
Types of Economic Systems
TYPE 2: Command Economy
Command economy—government makes
economic decisions
determines what to produce; how to
produce; who gets products
Wants of individual consumers rarely
considered
Government owns means of production:
resources and factories
Types of Economic Systems
TYPE 3: Market Economy
Market economy driven by choices of
consumers and producers
consumers spend money, go into
business, sell their labor as they wish
producers decide how to use their
resources to make the most money
Consumers, producers benefit each other
when they act in self-interest
Characteristics of Traditional
Economies
KEY CONCEPTS
Early societies all had traditional economies
Traditional systems help societies survive
Tend to be inefficient; do not adapt to change
Characteristics of Traditional
Economies
TRAIT 1: Advantages and Disadvantages
Advantages: little disagreement over goals,
roles
methods of production, distribution
determined by custom
Disadvantages: as result of resistance to
change, less productive
do not use new methods; people not in
jobs they are best suited for
low productivity results in low standard of
living
Characteristics of Traditional
Economies
TRAIT 2: Under Pressure to Change
Many traditional economies under pressure
to change
Kavango people of Namibia lived as
subsistence farmers for centuries
Modern telecommunications brought
Kavango images of outside world
thousands have moved to cities
a few have turned to commercial farming
Reviewing Key Concepts
Use each of the terms in a sentence:
traditional economy
command economy
market economy
Government Controls
KEY CONCEPTS
Centrally planned economy—central government
makes all decisions
Decides for whom to produce in part by setting wages
only some people have money to buy available products
Command Economies
Government Controls
EXAMPLE: Government Planning
In all societies, government exerts some control over
people’s lives
In centrally planned economy, government exerts
great control
determines businesses to operate, amount produced each month
determines who is employed, work hours, pay scales
Government Controls
EXAMPLE: Socialism and Communism
Karl Marx influenced some societies to adopt
command economies
socialism—government owns some of the factors of production
communism—no private property; little political freedom
Authoritarian system requires total obedience to
government
communism is authoritarian socialism
Government Controls
EXAMPLE: Socialism and Communism
Democratic socialism established under democratic
political process
government owns basic industries
other industries private
central planners make decisions for government-owned industries
central planners might control other sectors, such as health care
Karl Marx: Economic
Revolutionary
A New View of Economics
Marx lived during Industrial Revolution
Argued factory owners used workers as resource
exploited workers by keeping wages low to increase profits
workers would rebel, establish classless society
Wrote The Communist Manifesto (with Friedrich Engels),
Das Kapital
Command Economies Today
KEY CONCEPTS
No pure command economies today
modern telecommunications bringing about change
Some economies still have mostly command elements
Command Economies Today
North Korea
Communist North Korea used resources for military, not
necessities
built large army; nuclear weapons program
In 1990s and early 2000s, millions died of hunger, malnutrition
In 1990s, production decreased and economy shrank
Since 2003, some market activity allowed
Command Economies Today
Impact of Command Economies
In theory, command systems fair to everyone; In
practice, many disadvantages
central planners do not understand local conditions
workers have little motivation to be productive or conserve resources
artificially low prices lead to shortages
people sacrificed to carry out centrally planned policies
Reviewing Key Concepts
Write a brief paragraph explaining the links between
the following three terms:
centrally planned economy
socialism
communism
Fundamentals of a Market Economy
KEY CONCEPTS
Private property rights—right to own businesses and
resources
Property means material objects, money, intellectual
property, labor
Market—place or situation where people buy and sell
goods, services
Market Economies
Fundamentals of a Market
Economy
FEATURE 1: Private Property and Markets
Private property rights must be defined and protected
by law
Buyers must be sure sellers have right to sell products
they offer
Sellers must be sure they will be paid for their products
Fundamentals of a Market
Economy
FEATURE 2: Limited Government Involvement
Laissez faire—government should not interfere in
economy
Capitalism—system having private ownership of
factors of production
says producers will create products consumers demand
Actual market economies all have some government
involvement
Fundamentals of a Market
Economy
FEATURE 3: Voluntary Exchange in Markets
Voluntary exchange—traders believe they get more
than they give up
In market economy, most trade is exchange of product
for money
Profit—financial gain from business transaction
Fundamentals of a Market
Economy
FEATURE 4: Competition and Consumer Sovereignty
Competition—sellers’ efforts to get business by offering
best deal
Consumer sovereignty—buyers choose products,
control what is produced
Competition controls self-interested behavior
sellers offer low price or high value to please consumers, make profit
Fundamentals of a Market
Economy
FEATURE 5: Specialization and Markets
Specialization—people concentrate their efforts in the
activities they do best
encourages efficient use of resources
leads to higher-quality, lower-priced products
Circular Flow in Market Economies
KEY CONCEPTS
• Circular flow model illustrates how interactions occur in
a market
• Represents the two key decision makers: households,
businesses
• Shows the two markets where households and
businesses meet
• goods and services
• resources
Circular Flow in Market Economies
Product Markets
Product market—market where goods and services
bought and sold
includes all purchases by individuals from businesses
Circular Flow in Market Economies
Factor Markets
Factor market—market for the factors of production
land, labor, capital, entrepreneurship
Individuals own all factors of production
own some outright, such as labor; some indirectly, such as stocks
individuals are producers; businesses are customers
Circular Flow in Market Economies
Circular Flow
Circular flow model shows how market economies
operate
outside arrow shows flow of money
inside arrow shows flow of resources and products
Impact of Market Economies
KEY CONCEPTS
Late 1940s to early 1990s, many countries had
command systems
U.S.S.R., Eastern Europe, China, much of SE Asia, Cuba, North Korea
Most of these countries have now adopted market
systems
remaining communist countries using some market measures
Impact of Market Economies
Advantages
• Individuals free to make economic choices, pursue
own work interests
• Less government control means political freedom, less
bureaucracy
• Locally made decisions mean better use of resources,
productivity
• Profit motive ensures resources used efficiently, rewards
hard work
• resulting competition leads to higher-quality, more diverse products
Impact of Market Economies
Disadvantages
• Pure market economy has no way to provide public
goods and services
• Does not give security to sick or aged
• During U.S. industrial boom, business owners rich,
workers low pay
• Businesses did not address problems caused by
industrialization
• Industrialized societies adopt some government control
of economy
Reviewing Key Concepts
Explain the relationship between the terms in each
of these pairs:
private property rights and market
laissez faire and capitalism
specialization and profit
factor market and product market
Today’s Mixed Economies
KEY CONCEPTS
Mixed economy has elements of traditional,
command, market systems
most common type of economic system
Traditional, command, market economies adopt
elements from others
Modern Economies in a Global Age
Today’s Mixed Economies
Life in a Mixed Economy
Family farming in U.S. serves as example of mixed
economy
traditional: all members of family help bring in harvest
command: affected by government—public school, roads, Social Security
market: own land, sell their products in competitive market
Today’s Mixed Economies
Types of Mixed Economies
• Most economies emphasize one type; U.S. basically has
market system
• Many European countries greater mix of market and
command elements
• France—government controls some industries; provides social services
• Sweden—state owns part of all companies; lifelong benefits, high taxes
• Namibia—traditional; state supports market, foreign investment
Trends in Modern Economies
KEY CONCEPTS
Economies change in response to natural, social,
political changes
East European economies changed after fall of
communism
Trends in Modern Economies
TREND 1: Changes in Ownership
Economies in transition often go through changes in
ownership
To nationalize is to change from private to government
ownership
To privatize is to change from government to private
ownership
Trends in Modern Economies
TREND 2: Increasing Global Ties
• Growth of global economy—economic actions across
national boundaries
• recent agreements open up world markets to trade among countries
• fast, safe, cheap transport of resources, products eases distribution
• phone, computer links make financial transactions quick, inexpensive
• cross-border business partnerships lower research, production costs
Reviewing Key Concepts
Write a sentence that illustrates the meaning of
each of the following terms:
mixed economy
Nationalize
Privatize
global economy
Case Study: Contrasting
Economies: North Korea and
South Korea
Background
• Korea was a single country until end of World War II
• North Korea has communist government, command economy
• South Korea is democracy with market economy
What’s the Issue?
• How effective are command and market economies?
Thinking Economically
1. Based on documents A and C, in which country does the government appear to be more involved in controlling business and the economy?
2. Based on documents A and C, what can you infer about the effects of government activities on productivity in the two nations?
3. In today’s global economy, is a command economy or a market economy more likely to succeed? Support your answer with information presented in the three documents.