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Adam Smith’s Market Economy
Economic Logic of a Market System
AP Macroeconomics
Economic Systems Allocate Resources
• Market Command Traditional
Every Economic System has to answer 3 Questions:
1) What to Produce?
2) For whom to Produce?
3) How to Produce it? (or when to produce)
Society will choose an economic system based on goals: Economic & Social
WHAT ECONOMIC SYSTEM?Which Economic System?
• Growth
• Employment
• Efficiency
• Stability
•Justice
•Equality
•Environment
•Freedom
Adam Smith (1723-90)
• Founder of Free Market Economics
• Argued: Free markets best promote the social welfare
• Government should not interfere!
“The Wealth of Nations” Published in 1776
"It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
“We address ourselves, not to their humanity but of their advantages."
Adam Smith
Self-interest is our incentive to work hard
End Result:
Reading: The Free Market at Work
ScarceResources
HighPrices
Adam Smith & The Invisible Hand
People follow their own self-interest
Threat of competition keeps people honest
Markets naturally self-regulateInvisible Hand
Shortage ofA Good?
Government should notInterfere!
HOW WHAT FOR WHOM
MARKET
COMMAND
TRADITIONAL
Economic System
Production
Growth &
Efficiency
Supply &
Demand
Price
Communism
• Soviet Union “adopts” command economic system
• General Philosophy: – Government controlled economy (centrally planned)
– stressed equality & the common good (collective society)
• Economic Incentive to invent, work hard ?
Karl Marx
1848
Economic Systems Trade-offs
• Efficiency vs. Equity– Free markets focus on efficiency not equity
• Efficiency means society gets the most from its scarce resources
• Equity means the benefits of scarce resources are distributed fairly in society
HOW WHAT FOR WHOM
MARKET
COMMAND
TRADITIONAL
Economic System
Production
Growth &
Efficiency
Supply &
Demand
Price
Equality
Gov’t orCentral PlannerEmployment
Need
[Tradition]
Need/
NecessityStability
Traditional Economic System
Bhutan Video: Traditional Economy
Benefits Costs
Bhutan June 2011
Typical Village
No traffic lights in Bhutan
2011 Music Video production in Bhutan
HOW WHAT FOR WHOM
MARKET
COMMAND
TRADITIONAL
Economic System
Production
Growth &
Efficiency
Supply &
Demand
Price
Equality
Gov’t orCentral PlannerEmployment
Need
[Tradition]
Need/
NecessityStability
Summary
• Market systems stress competition– Work “individually” in your own “self interest”
– Invisible hand regulates economy
• Command systems stress equality– Work “collectively” for the common good
– Government centrally plans economy
• Traditional systems stress preservation of culture– Government maintains culture of society