Economic Systems

Human wants are unlimited, but resources are not.

Economic System

An economy, or economic system, is the way a nation makes economic choices about how the nation will use its resources to produce and distribute goods and services.

Resources, also called factors of production, are all the things used in producing goods and services.

The basic resources available to a society are:

•Natural

•Human

•Capital

5

The Factors of Production

ProductProduct

NaturalNaturalHumanHuman

CapitalCapital

• Natural refers to everything on Earth that is in its natural state, or Earth's natural resources.

• Human refers to all the people who work in the economy.

• Capital refers to the things that are themselves produced and then used to produce other goods and services. Examples: tools, equipment, computers, desks, trucks, buildings

Three Economic Questions

All economies must answer three questions:

1. What goods and services will be produced?

2. How will they be produced?

3. For whom will they be produced?

The Economic Problem

Given scarce resources, how do societies answer the three basic economic questions?

Every society has some system that transforms that society’s scarce resources into useful goods and services.

10

Three Economic Systems

• Traditional Economy

• Command Economy

• Market Economy

Standards Used to Distinguish Economic Systems

Some standards used to distinguish among economic systems are:

• Who owns the resources?

• What decision-making process is used to allocate resources and products?

• What types of incentives guide economic decision makers?

Traditional Economy

In a traditional economy, goods and services are produced by the family for their personal consumption.

A traditional economy is shaped largely by custom or religion.

Traditional Economy

In a traditional economy, resources are allocated according to long-lived practices from the past. There is little surplus (something extra) and little trade (or exchange of goods).

Traditional Economy

In a traditional economy, there is only a limited need for markets (places to buy and sell goods and services).

Traditional Economy

A traditional economy is the type of economy found in less developed nations,

usually in rural areas.

Command Economy

In a command economy, all resources are collectively owned and directed by the government.

In a command economy, the government decides what and how much to produce.

In a command economy, the government answers the three basic economic questions:

1. What? A dictator or a central planning committee decides what products are needed.

2. How? Since the government owns all means of production in a command economy,it decides how goods and services will be produced.

3. For whom? The government decides who will get what is produced in a command economy.

Command Economy

In a command economy, the government decides where to locate economic activities.

Command Economy

In a command economy, the government decides what prices to charge for goods, including agricultural goods and services.

Command Economy

In a command economy, economic decisions are often made to further the goals of the government.

Command EconomyIn a command economy, production costs (how much it costs to make an item), are not reflected in the cost of the item.

For example, in a command economy it might cost $2.00 to produce a loaf of bread, but the price might be set at $1.00 in order to ensure that customers are able to afford adequate food.

Command Economy

In a command economy, the price might be set higher than the production costs.

For example, in a command economy it might cost $5,000.00 to produce a car, but the price might be set at $10,000.00 in order to ensure that only the wealthy can buy it.

Market Economy(free enterprise, capitalism)

Individual producers must figure out how to plan, organize, and coordinate the production of products and services.

In a market economy, resources are allocated through individual decision making.

Market Economy(free enterprise, capitalism)

• In a free-market country, people can own their own businesses and property. People can also buy services for private use, such as healthcare.

(But most capitalist governments also provide their own education, health and welfare services. )

Market Economy(free enterprise, capitalism)

• In a market economy, prices act as signals of scarcity. When the price of something is high, that means it's more scarce. Demand for it is high relative to the supply.

Market Economy(free enterprise, capitalism)

• When the price of something is low, then it's less scarce. By observing prices, consumers and producers can choose their behavior to respond to scarcity.

Market Economy(free enterprise, capitalism)

• High prices encourage producers to switch from more scarce to less scarce resources, and they encourage consumers to switch from products and services that require more scarce resources to products and services that require fewer scarce resources.