Chapter 2: Economic Systems and Tools

Section 2.1 Economic Questions and Systems (33)

The Three Economic Questions

All economies must answer 3 questions :• What __________ and _____________ will be

produced?• _____________ will they be produced?• __________________ will they be produced?

The Three Economic Questions (continued)

Some standards used to distinguish among economic systems are:• __________ owns the resources.• What decision-making process is used to

_________________resources and products.• What types of ____________________ guide

economic decision makers.

Pure Market Economy• In a pure market economy _____________ firms

account for all production.• There is no _____________ involvement at all.• Features of this economic system include.– the _______________ ownership of all resources, and – the coordination of economic activity based on the

prices generated in free, _________________ markets.• Any ___________________ derived from selling

resources goes exclusively to the resource owners.

The Invisible Hand of Markets• According to __________

____________market forces coordinate production as if by an “invisible hand.”

• Smith argued that although each individual pursues his or her self-interest the “invisible hand” of market competition promotes the _________________________.

• _____________________ choices in competitive markets answer the questions what, how and for whom.

Problems with Pure Market Economies• The most notable market failures include: – Difficulty enforcing ________________ rights• In a pure market economy, there is no government, so

there is no central authority to ________________ property rights, enforce contracts, and otherwise ensure that the rules of the game are followed

– Some people have few ________________ to sell• Because markets do not guarantee even a minimum

level of _____________________, some people would have difficulty surviving

Problems with Pure Market Economies (cont’d)– Some firms try to ___________________ markets• Despite the theory of the “invisible hand” some

producers may try to monopolize the market by either unfairly driving out ________________ or by conspiring with competitors to increase prices

– No __________________ goods• _________________________ firms do not

produce so-called public goods such as national defense.

Problems with Pure Market Economies (cont’d)– Externalities• ______________________ reflect the

benefits to buyers and the cost to sellers• Some production and consumption affect

____________ – those not directly involved• Private markets _______________ to

account for externalities• Because of this type of market failure, even

market economies allow a role for _________________________.

Pure Command Economy• In a pure command economy, all resources are

_____________________________and production is coordinated by the central plans of government ________________.

• In theory, there is public, or __________________, ownership of all resources.

• A command economy is sometimes called _________________.

• ______________________ answer the 3 economic questions by spelling out how many missiles, how many homes and how much bread to produce.

• Central planners also decide ________________________ these goods and who should get them.

Problems with Command Economies• __________________________get low priority• ___________________ freedom of choice.• Central planning can be _________________ – the

former Soviet Union had a command economy.• Resources owned by the central authority are

sometimes wasted – nobody has an _______________________ to see that resources are employed in their highest-valued use.

• Environmental Damage – in theory command economy should take better care of the

environment than a market economy – common good; directors of state enterprises are often more concerned with meeting ____________________ goals set by central planners

Mixed Transitional and Traditional Economies• No country represents either a market

economy or a command economy in its pure sense!

• Most economies now mix central planning with competitive markets and are called ______________________________.

Mixed Economy• The United States is a mixed economy - it is

also considered a ________________ economy because markets play a relatively large role

• Government accounts for about ________________ of all U.S. economic activity

• Government also _______________________ the U.S. private sector in a variety of ways

• Federal bodies regulate workplace safety, environmental quality, competition in markets, and many other activities.

Transitional EconomyAn economic system in the process of shifting from __________________ planning to _________________ markets.• More than two dozen countries are

transitional economies • The transition involves converting government

enterprises into private enterprises – a process called ____________________.

Traditional Economy• An economic systems shaped largely by

___________________or religion; examples:– India - _______________ system restricts

occupational choice– Charging interest is __________________ under

Islamic law– ________________ relations also play significant

roles in organizing and coordinating economic activity