CHAPTER TWOCHAPTER TWO

3 Basic Questions

1. What goods and services should be produced?

2. How should these goods and services be produced?

3. Who consumes these goods and services?

What to Value? Economic System – method

used by a society to produce and distribute goods and services

Easiest way to distinguish an economy is by who answers the basic questions OR owns and controls the factors of production

Dependent upon that society’s goals and values.What should a society value? What do you value?Do different societies have different values?

Goals & Values Economic Efficiency – maximize what you can

get with what you have to work with. Economic Freedom – be able to make your own

decision from a variety of choices. Economic Security – knowing you can find the

goods/services that you need. safety net – set of government programs that protect

people experiencing unfavorable economic conditions Economic Equity – does everyone get the

same? Economic Stability Economic Growth – the economy must grow for

a nation to improve. standard of living – level of economic prosperity

Traditional Economies Relies on habit, custom,

or tradition to answer

the 3 basic questions.OR the village controls the factors

of production--resources are shared

Everything revolves around

family Your occupation would be what your ancestors have

always done

Small and close communities that engage in subsistence agriculture

Traditional Society ADVANTAGES Simple, natural, caring

DISADVANTAGES Struggle to cope with large

disasters Slow to adapt to change Lack modern conveniences No social mobilityhttp://www.youtube.com/watch?v=HN3EecB9fGM&feature=related

Market EconomiesMarket Economies Individuals answer the basic

questions based on exchange or trade.Factors of production are privately

owned

Choices determine what is produced and who gets it.

Also referred to as theFree Market or Capitalism.

Why Engage in Exchange?

Self-interest motivates people to exchange and tradeBy looking out for their own utility (getting what they

want) society becomes better off○ Producers seek greater profit, workers higher wages,

consumers the best deal

Competition regulates the market and keeps it reasonably fairProducers seek profit and low costsConsumers seek the best deals to satisfy their wants

and needs

Incentive – ways of altering behavior (taxes, punishment, candy) Economists believe few problems cannot be solved by the right

incentives

Invisible Hand – phenomenon by which a market operates fairly without planning Consumers get what they want, as do producers

Free Market Market – arrangement of buyers

and sellers to exchange things. Flea market, ebay

Specialization – makes businesses and the economy more productive and efficient

Households / individuals own the factors of production

Markets organize trade and exchange in a non-fraudulent way Allows all parties to benefit

“The meaning of economic freedom is this: that the individual is in a position to choose the way in which he wants to integrate himself into the totality of society.” ~Ludwig von Mises

Factor & Product Markets

All economic transactions take place on one of two markets

Factor market – resources are bought and sold (raw)Rent, land, labor

Product market – where goods/services are purchased by households (cooked)

Raw vs. CookedRAW

Factors of production Resources “Raw materials”

COOKED

Goods and services Ready to be bought

and sold “Finished products”

Free Market AdvantagesFree Market Advantages Efficiency –

highly productive and responds rapidly to change

Freedom – work, produce, consume how/want you want

Potential for Growth – creative destruction, innovation

Consumer Sovereignty – “customer is king”If anyone rules the free market, it is the

consumerIf you don’t like it—don’t buy it!

Free Market Free Market DisadvantagesDisadvantages

Vast amounts of inequality and insecurityGreater chance of failureOR wealth is spread

unevenly Not only is a large

percentage of the population in poverty, but a disproportionate amount of the population holds the majority of the wealth

Command Economies Central government answers basic economic

questions.Government controls

the resourcesDistribution based on

equity

No choices given to people.Elite inner circle of

planners decide what & how much gets made along with how much to charge for it○ Thus the name “Central Planning”

Stalin at the Helm

Centrally Planned Centrally Planned EconomiesEconomies Government controls factors of

production and wages, sets prices and output goals

Communism - (authoritarian) complete governmental control

Socialism – blend of centrally planned and free market systemsincludes high degrees of regulation, high

taxation, large safety nets and some economic planning

Disadvantages:Central Planning No efficiency

Poor quality, shortages

Performance never meets ideals Lack of incentives

No innovation or profit, no private property, price controls

Sacrifice of individual freedoms Gov’t decides what industries are Gov’t decides what industries are

essential essential

Advantages: Central Planning No competition

Few business failures and few mega-rich citizens

Basic securityEssential amounts of most

necessities are availableEx: healthcare, cooking oil, bread…

General equalityMajority of population experiences

a similar lifeNo class divisions, jobs for mostWealth theoretically spread more evenly

Mixed Economies Market-based economy

with government making some

decisionsGood deal of

control and regulation

Most modern economies are mixed.China, India, the US

Modern Economies

Transition – economies typically moving from centrally planned to free-market are characterized by a few observations:

Privitization – businesses are transferred from state (gov’t) control to individuals, allows for competition

Less nationalization—fewer state-run firmsRespect for rule of law and private propertyEncourages outside investment

http://www.youtube.com/watch?v=XiXs7oBynYA

Bovine Economics Bovine Economics COMMUNISM: You have two

cows. The government takes both and gives you some of the milk.

SOCIALISM: You have two cows. The government takes one cow and gives it to your less fortunate neighbor.

TRADITIONAL: You have two cows; you want chickens; you set out to find another farmer who will trade eggs for milk.

CAPITALISM: You have two cows. You sell one and buy a bull.