Economic SystemsChapter 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

1) What goods or services should be produced?

-How much resources should be devoted to national defense? Education? Health care?

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?

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

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

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 2Section 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

Adam Smith Assignment And answer these questions on the right hand

side. They should be full paragraphs, not 2 or 3 sentences

1) Rewrite in modern teenage language what Adam Smith is saying in the opening passage of “An Inquiry into the Nature and Causes of the Wealth of Nations (1776)” found on page 1.

2) How did Adam Smith envision the universe? Do you agree with his assessment of divine right on page 2?

3) What is meant by the term “invisible hand”?

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 2Section 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