Comparative Economic Systems

Every society must answer three questions:

The Three Economic Questions1. What goods and services should be

produced? 2. How should these goods and services be

produced? 3. Who consumes these goods and services?

The way these questions are answered determines the economic system

An economic system is the method used by a society to produce and distribute goods and services. 2

Economic Systems

1. Centrally-Planned (Command) Economy

2. Free Market Economy3. Mixed Economy

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Centrally-Planned Economies

(aka Communism)

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Centrally Planned EconomiesIn a centrally planned economy (communism) the

government… 1. owns all the resources. 2. decides what to produce, how much to produce, and

who will receive it.Examples:Cuba, North Korea, former Soviet Union, and China?

Why do centrally planned economies face problems of poor-quality goods, shortages,

and unhappy citizens? NO PROFIT MEANS NO INCENTIVE TO W!!

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Characteristics of Communist Economies

Role of the Communist Party In any communist-run nation, the Communist Party holds the decision-making power in both the government and the economy.

Central Planning Government officials plan and supervise production in factories, farms, and stores.

Collectivization Collective or state ownership of the means of production is one pillar of communism. Collectivization is the process of merging small private farms into large government-owned agricultural enterprises.

State Ownership Industrial enterprises, transportation, and other parts of the economy are also state-owned.

China and Other Communist Nations

Cuba• Fidel Castro led a revolution in

Cuba in 1959 to overthrow a corrupt government. In 1961, Castro declared himself a Marxist and the country became communist in nature.

Asia• North Korea is one of the few

remaining communist countries in the world.

• Communism also spread in the Southeast Asian countries of Vietnam, Laos, and Cambodia during the mid-1970s.

China• When Mao Zedong took

control of China in 1949, the country developed its own version of central planning.

• The Chinese economy today, however, has evolved into a mix of state-controlled enterprises and a growing class of private enterprises.

Advantages and Disadvantages

1. Low unemployment-everyone has a job2. Great Job Security-the government

doesn’t go out of business3. Equal incomes means no extremely

poor people4. Free Health Care

What is GOOD about Communism?

What is BAD about Communism?

1. No incentive to work harder

2. No incentive to innovate or come up with good ideas

3. No Competition keeps quality of goods poor.

4. Corrupt leaders5. Few individual

freedoms8

Advantages/disadvantages of Communism

• What do you think are some advantages and disadvantages of Communism?– Adv:

• Theoretically no social classes• Whole country works together• Everyone gets an equal amount of wealth and resources

– Disadv:• Absolutely NO MOTIVATION to work hard• No private ownership• Gov’t controls wages/prices• Often times becomes a dictatorship and the economy

eventually collapses • Not enough resources for everyone to get an equal

share—Shortages

Free Market System(aka Capitalism)

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Characteristics of Free Market1. Little government involvement in the economy.

(Laissez Faire = Let it be) 2. Individuals OWN resources and answer the

three economic questions.3. The opportunity to make PROFIT gives people

INCENTIVE to produce quality items efficiently.

4. Wide variety of goods available to consumers. 5. Competition and Self-Interest work together to

regulate the economy (keep prices down and quality up).

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• Right to own private property is unlimited

• Most industry is owned by private individuals

• Competition and profit are not regulated by the government

Example of Free MarketExample of how the free market regulates itself:If consumers want computers and only one company is making them… •Other businesses have the INCENTIVE to start making computers to earn PROFIT. •This leads to more COMPETITION….•Which means lower prices, better quality, and more product variety. •We produce the goods and services that society wants because “resources follow profits”.

The End Result: Most efficient production of the goods that consumers want, produced at the lowest

prices and the highest quality.13

Example of CommunismExample of why communism failed:If consumers want computers and only one company is making them… •Other businesses CANNOT start making computers. •There is NO COMPETITION….•Which means higher prices, lower quality, and less product variety. •More computers will not be made until the government decides to create a new factory.The End Result: There is a shortage of goods that consumers want, produced at the highest prices

and the lowest quality.14

The Invisible HandThe concept that society’s goals will be met as

individuals seek their own self-interest.

Example: Society wants fuel efficient cars…•Profit seeking producers will make more.•Competition between firms results in low prices, high quality, and greater efficiency. •The government doesn’t need to get involved since the needs of society are automatically met.

Competition and self-interest act as an invisible hand that regulates the free market.

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• Mixed Economy--An economy in which private enterprise and governmental participation coexist

• U.S.-– Individuals own businesses/corporations– Government prohibits trusts/monopolies,

operates public education, the US postal service, sets minimum wages, etc.

What do you think are some advantages and

disadvantages of Capitalism?

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Advantages/Disadvantages of Capitalism

– Adv:

• CHOICE

• Competition

• Opportunity for profit

• Plenty of incentive to work hard and improve products

– Disadv:

• RISK

• Possibility of Monopolies (Prices set by businesses)

• Economy fluctuates

• Large Businesses dominate small ones

Connection to the PPC

Communism in the Long Run

Free Markets in the Long Run

Consumer goods

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FUTURECURVE

Consumer goodsC

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FUTURECURVE

CURRENTCURVE

Puerto RicoCuba19

• What are the factors of production?• How can we describe the free enterprise system

and the laissez-faire theory? • What is the role of government in a mixed

economy?• How are business organizations classified?• What role do profit and loss have in a free

enterprise system?

Factors of production

Land

• One factor of production is land, which in economic terms includes all natural resources.

Labor

• Labor is the work done by men and women to produce goods and services.

Capital

• Capital includes all the human-made resources that are used to produce goods and services. Someone who owns capital and puts it to productive use is called a capitalist.

TEntrepreneurRoleof the Entrepreneur

• An entrepreneur is an individual with the drive and ambition to combine land, labor, and capital resources to produce goods or offer services.

Free Enterprise System

Private Ownership The resources used to produce goods or services are owned by private individuals or corporations.

Profit The “profit motive” is the desire to gain from business dealings.

Individual Initiative All individuals are free to start and run their own businesses.

Competition Competition is a situation in which a number of companies offer the same product or service. Under competitive conditions, prices are determined by the laws of supply and demand.

The free enterprise system is an economic system characterized by private or corporate ownership of capital goods and investments that are determined by private decision rather than by state control.

Laissez-Faire Theory and Mixed Economies

Laissez-Faire Theory• Laissez-faire theory holds

that government should play a very limited, hands-off role in society.

• The proper role of government in economic affairs should be restricted to functions intended to promote and protect the free play of competition and the operation of the laws of supply and demand.

A Mixed Economy• Economists usually describe

an economy in which private enterprise and governmental participation coexist as a mixed economy.

• The American economy is a mixed economy.

• Government at all levels in American society has some influence on the economy.

Types of Business OrganizationsSole Proprietorships

• Businesses owned by a single individual are sole proprietorships.

Partnerships• Businesses owned by two or more individuals, called

partners, are partnerships.• A corporation has many owners, called shareholders.

A share is a fraction of ownership in the corporation.• Corporations have the advantage of being able to draw

from large pools of investor capital, but also have the disadvantage of having their earnings taxed twice.

Profit and Loss

• Profit is the amount of money you earn from the business once costs incurred running the business have been subtracted.

• If earnings are less than the costs, the business has not made a profit; instead, it has taken a loss.

• Taking risks and making investments are an essential part of the capitalist system.

Socialism

• What is socialism?

• What are some important characteristics of socialist economies?

• How can we describe socialism in developing countries?

• What are the pros and cons of socialism?

What is Socialism?What is Socialism?

• Socialism – the economic and political philosophy that wealth should be fairly distributed through a society.– Public ownership of the factors of production

– Politically they may be democratic; economically they depend on the government doing the centralized planning.

– Reject individualism and competition for profit that underlies the capitalist system. Instead, they emphasize cooperation and social responsibility.

The Industrial RevolutionThe Industrial Revolution• Most of current socialism began in the 19th century with the spread of the

Industrial Revolution. Many people upset by the 16 hour days in unsafe

conditions for low pay, with small children working alongside parents.

Living conditions of workers poor.

• Karl Marx (1818-1883) is the father of modern socialism and was the

most significant critic of capitalism during the 19th century.

Socialists and Communists

–Communists believe that socialism can only occur by

revolution

–Socialists believe that socialism can occur peacefully

through the democratic process.

Characteristics of Socialist EconomiesCharacteristics of Socialist Economies• Nationalization – placing businesses under government control.

– Some countries, like England, pay the former owners a fair price. Others take over without giving any compensation to the owners.

– Rarely do socialist countries nationalize all businesses. They usually pick sectors with lots of workers or a few dominant companies, like utilities, transportation, steel. Others remain in private hands.

– Many socialist governments want the workers to control the businesses. Sweden’s Social Democratic Party wants to transfer ownership of private companies to their workers.

• Public Welfare – providing for equal distribution of necessities and services, such as inexpensive health care, retirement pensions, free university education, housing for the poor.– Countries that provide these services at little or no cost to the users are

often called welfare states. People who lose their jobs or are unable to work often receive gov’t payments almost as high as their prior salaries. All people above retirement age receive gov’t pensions. Workers in Europe receive paid maternity leave and many weeks of paid vacation each year.

• Taxation – in socialist countries, because of the cost of public

welfare programs, taxes are generally higher than in capitalist

countries, sometimes taking 50-60% of a person’s income.

Graduated tax (?) so that it may be 90% of a wealthy person’s

income.

• Centrally Planned Economy – government bureaucrats decide

how an economy will develop over a given number of years. Set

targets for production and direct investments into specific

industries. Also called a command economy.

• Most modern countries have mixed economies. There is a range of

being closer to a free market or closer to a socialist economy.

Socialism in Developing CountriesSocialism in Developing Countries• Socialism is very popular in developing countries

– No tradition of locally or individually controlled industry – starting from scratch at trying to build industry

– Large industries often owned by foreign companies – by nationalizing them and putting local people in charge, leaders can get broad support

– If a leader wants to direct the economic efforts of a nation behind certain industries, easier to do if socialist than capitalist.

– Sometimes leaders ignore production of basic needs like food and consumer goods. This can cause unrest and political instability, which leads some governments to turn to authoritarian methods.

– Few developing countries have succeeded in implementing democratic versions of socialism found in the industrial world.

Pros and Cons of SocialismPros and Cons of Socialism

• Pros– Fair to supply everyone

basic needs like medical care– Evens out inequalities that

exist in capitalism– Makes political democracy

work better because there is economic democracy

– Gives workers and ordinary citizens more control over their lives – companies could not just close without consideration of the workers and community in the area.

• Cons– Bureaucracy complicates

decision making and cannot act quickly to take advantage of new technologies

– Invisible hand of market place is more efficient than the visible hand of central planning

– Individuals have less incentive to work harder because so much of their income is taken by the government and their basic needs are provided for anyway.

Advantages/Disadvantages of Socialism

– Adv:

• Everyone is closer to ECONOMIC EQUALITY

• Poverty is almost eliminated

• Resources go where they are most needed

– Disadv:

• High Taxes

• Less Incentive to work hard/improve

• No Competition within major industries

• Resources can be limited thus causing shortages