1

What is an Economic System?

An organization and methods used to determine:

WHAT goods and services are produced and in WHAT quantity.

HOW they are produced. WHOm are the goods and services

produced for?

2

What are the basic types of Economic Systems?

• Traditional• Command• Market

3

What is aTraditional Economy?A system that answers

the What, How, and For Whom questions the way they always have been answered

CUSTOM TRADITION

4

What is the Benefit of a Traditional

Economy?There is little friction among

members because relatively little is disputed

5

What are the Disadvantages of a

Traditional Economy?Restricts individual initiative Lack of advanced goods, new

technology, and growth.

6

What is aCommand Economy?

A system that answers the What, How, and For Whom questions by central authority

7

What are the Strengths of a

Command Economy?stable = lots of security.

Social welfare

Equity

8

What are the Weaknesses of a

Command Economy?Lack of growth and expansion.Decision makers have the power to be

absolutely wrong.Quality and variety of goods suffer.Lack of motivation = lack of innovation

Stagnate economySelf-interest Private property

9

What is aMarket Economy?

An economic system that answers the What, How, and For Whom questions using prices determined by the interaction of the forces of supply and demand

producers consumers

10

What are the advantages of a Market Economy?

VarietyInnovationHigher qualityLower pricesSelf regulating

11

What are Criticisms of a Market Economy?

• Dynamic and unpredictable• Lack of stability and security. • Externalities-How do you deal with

things outside of supply and demand?

• Lack of public goods• Income inequality-large gap

between the rich and the poor.

12

What is aMixed Economy?

An economic system that answers the What, How, and For Whom questions through a mixture of traditional, command, and market systems

13

What is Capitalism?An economic system

characterized by private ownership of resources and markets

14

Who was Adam Smith?

• He wrote the “Wealth of Nations” 1776

• Advocate of Free Enterprise/capitalism

• Famous for acknowledging the “invisible hand”

• Central difference-Capitalism vs Socialism/Communism– Individual vs Community

15

What isConsumer Sovereignty?The freedom of consumers

to cast their dollar votes to buy, or not to buy, at prices determined in competitive markets

16

What is Communism?A stateless, classless

economic system in which all the factors of production are owned by the workers and people share in production according to their needs

17

Who was Karl Marx?He co-authored the

“Communist Manifesto” 1848

His criticism of capitalism advanced communism

18

What is Socialism?An economic system

characterized by government ownership of resources and centralized decision making

19

What are the Characteristics of

Socialism?Public ownershipCentralization

20

What are the Strengths of Socialism?

• A more equitable distribution of income and benefits

• reduced unemployment

21

What are theWeaknesses of Socialism?Inefficiencies occurAbsence of entrepreneurship

stifles growth and innovation

22

A Classification of Economic Systems

Cuba

Pure socialism

Hong Kong

U.S., Canada, Western Europe

France, Sweden,

Israel

Mexico, Latin

America, Japan

China, former Soviet Union

Pure capitalism

23

Key Concepts

24

Key Concepts• What is an Economic System?• What are the basic types of Economic Systems?• What is a Traditional Economy?• What is a Command Economy?• What is a Market Economy?• Who was Adam Smith?• Who was Karl Marx?

25

Key Concepts cont.

• What is the Invisible Hand?

• What is a Mixed Economy?

• What is Capitalism?

• What is Communism?

• Who was Karl Marx?

• What is Socialism?

26

Summary

27

An economic system is the set of established procedures by which a society answers the What, How and For Whom to produce question.

28

Three basic types of economic systems are the traditional, command, and market systems. The traditional system is based on decisions made according to custom, and the command system answers the three economic questions through some powerful central authority. In contrast, the market system uses the impersonal mechanism of the interaction of buyers and sellers through markets to answer the What, How, and For Whom questions.

29Consuming units

Producing units

Supreme planning agency

Specialized planning agencies

The Command Economy Pyramid

30

Capitalism is an economic system in which the factors of production are privately owned and economic choices are made by consumers and firms in markets. As prescribed by Adam Smith, there is an extremely limited role for government, and self-interest is the driving force, held in check, or regulated, by competition.

31

Consumer sovereignty is the determination by consumers of the types and quantities of products that are produced in an economy.

32

Socialism is an economic system in which the government owns the factors of production. The central authorities make the myriad of society’s economic decisions according to a national plan. The collective good, or public interest, is the intended guiding force behind the central planners’ decisions.

33

Communism is an economic system envisioned by Karl Marx to be an ideal society in which the workers own all the factors of production. Marx believed that workers who worked hard would be public spirited and would voluntarily redistribute income to those who are less productive. Such a communist nation described by Marx does not exist.

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Chapter 29 Quiz

©2000 South-Western College Publishing

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1. The economic system in which all of the basic decisions are made through a centralized authority, such as a government agency, is termed a a. market economy.b. capitalistic economy.c. command economy.d. traditional economy.

C. To answer the three basic economic questions, the market economy uses the price system and a traditional economy is based on customs.

36

2. Command economies typically suffer from a. unemployment, but not underemployment.b. neither unemployment nor

underemployment.c. both unemployment and underemployment.d. underemployment, but not unemployment.

D. Command economies assign people jobs rather than allow the market system to determine wages and employment.

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3. Adam Smith stated that the only role of government in society should be toa. provide defense.b. enforce contracts.c. do absolutely nothing.d. both (a) and (b).

D. Adam Smith believed in a limited role of the government to provide national defense, education, maintain infrastructure, enforce contracts, and little else.

38

4. When making economic decisions, Adam Smith urged society to a. follow the principle of self-interest.b. follow the principle of public interest.c. transfer wealth according to need.d. provide equal income for all citizens.

A. Adam Smith stated “By pursuing his own interest he frequently promotes that of the society more effectively than when he really intends to promote it.”

39

5. The doctrine of laissez faire a. advocates an economic system with

extensive government intervention and little individual decision-making.

b. was advocated by Adam Smith in his book The Wealth of Nations.

c. was advocated by Karl Marx in his book Das Kapital.

d. none of the above.B. Laissez faire is a French expression

meaning “allow them to act” stated differently, “The least government is the best government.”

40

6. In Adam Smith’s competitive market economy, the question of what goods to produce is determined by the a. “invisible hand” of the price system.b. “invisible hand” of government.c. “visible hand” of public interest.d. “visible hand” of laws and regulations.

A. The “invisible hand” refers to a system where no central authority makes the key economic decisions, but rather decisions are make collectively by all consumers and producers in the economy.

41

7. Adam Smith wrote that thea. economic problems of the 18th-century

England were caused by free markets.b. government should control the economy

with an “invisible hand.”c. pursuit of private self-interest promotes the

public interest in a market economy.d. public or collective interest is not promoted

by people pursuing their self-interest.

C. Adam Smith recognized that everyone making decisions based on their own self interest would enhance the public interest.

42

8. Adam Smith, in his book The Wealth of Nations, advocateda. socialism.b. an economy guided by an “invisible

hand.”c. government control of the “invisible

hand.”d. the adoption of mercantilism.

B. Adam Smith advocated a laissez faire stance by government. That is, the government should provide the foundation for a free market system, but should not be a major participant in answering the questions of What, How, and for Whom.

43

9. The economic system in which private individuals own the factors of production is a. a planned economy.b. capitalism.c. collectivism.d. socialism.

B. For answers a,c, d, resources or factors of production are owned by the government.

44

10. Which of the following is not a basic characteristic of capitalism? a. Economic decisions occur in markets.b. Factors of production are privately

owned.c. Income is distributed on the basis of need.d. Businesses make their own product and

price decisions.

C. Karl Marx believed people would be motivated by the principle “from each according to his ability, to each according to his need.”

45

11. According to Karl Marx, under capitalism, a. profits would be shared fairly.b. incomes would be distributed equally.c. workers would be exploited and revolt

against owners of capital.d. workers would actually own the factors of

production.

C. Karl Marx believed that private ownership and profits lead to exploitation. The result is a class struggle between a few “haves” and “havenots.”

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12. Karl Marx predicted which of the following? a. market system would self destruct.b. “haves” would revolt against the “have-

nots.”c. wealthy were entitled to profits as their

reward for risk-taking.d. none of the above.

A. Karl Marx argued the market system would destroy itself because owners would go too far and pay starvation wages in order to maximize profits.

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13. How many nations in the world today operate totally according to Karl Marx’s theory of communism?a. None.b. Several.c. Only the United States.d. Many.

A. Under Marx’s idealized society of communism, people would distribute wealth according to need and no central authority would be necessary.

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14. In Marx’s ideal communist society, the statea. actively promotes income equality.b. follows the doctrine of laissez faire.c. owns resources and conducts planning.d. does not exist.

D. Under Marx’s idealized society of communism, individuals with ability would distribute the wealth of society according to each person’s need.

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15. Karl Marx was a (an)a. 19th-century German philosopher.b. 18th-century Russian economist.c. 14th-century Polish banker.d. 19th-century Russian journalist.

A. Karl Marx was born in Germany, the son of a lawyer. Marx was an outstanding student at Berlin University. In 1841, after receiving a doctorate in philosophy, he turned to journalism.

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