Lecture #6: Economic Systems

Three Economic Questions3

Questions• Every society must answer the following questions to define its economic system (what, how, who):

#1-What? • What goods will be produced?

• Because of scarcity, no country can produce every good it wants in the quantity it would like.

Three Economic Questions cont.#2-How? • How will the goods be produced?

• Will production decisions be made by individuals or by the government?

• Will producers use existing technology or new technology?

Three Economic Questions cont.#3-For Whom?

• For whom will the goods be produced?

• Will the government decide?

Will price decide?

• Will goods be produced for the purpose of trade with other countries?

Two Major Economic SystemsFree

Enterprise• individuals own all or most of the resources and control their use•A.K.A. capitalism or a market economy

Socialism • government may control or own many of the resources• A.K.A. command economy• communism is an ex. of socialism

Adam SmithAdam Smith (1723-1790)

Believed:•Free enterprise produced the most goods and services, and is the most ethical economic system•Self-interest causes people to work hard & take risks•We are led by an “invisible hand” to do good for others•Laissez-faire—“let it be”—governments should not interfere with trade or commerce—became a synonym for free enterprise •Competition keeps prices down & quality up

Who came up with Socialism? 1848, 2 Germans, Karl

Marx & Frederick Engels wrote the Communist Manifesto

They were distressed by the extremely poor conditions of the working class in factories.

Karl MarxKarl Marx

(1818-1883)

•Believed many failures & injustices with free enterprise•His ideas are the heart of socialism & communism•Said self-interest hurting others•Believed capitalists exploited workers

•Labor theory of value—the belief that all value in produced goods comes from labor

•Value is determined by how much time it took to make

•Surplus Value—the difference between the total value of production & the subsistence wages paid to workers.

•ex: it takes 5 hrs to make a chair & 10 hrs to make a table, this makes the table twice as valuable as the chair.

Differences between Free Enterprise & Socialism

Resources • F.E.—resources are owned & controlled by individuals

•Soc—resources are controlled by govt

•Ex: North Korea—the govt owns almost all the resources.

Differences between Free Enterprise & Socialism cont.

Govt’s Role

• F.E.—govt plays small role•Doesn’t make decisions about what goods will be produced, how they should be produced, & how much they should cost!

•Soc—govt plays large role•Control Prices•Write an Economic Plan—a plan that specifies the direction economic activities are to take

Differences between Free Enterprise & Socialism cont.

Income Distribution

•Refers to how all the income earned in a country is divided among the different groups of income earners.

•F.E.—govt pays little attention to

•Soc—govt will redistribute income•Usually away from high earners.

Differences between Free Enterprise & Socialism cont.

Controlling Prices

•F.E.—prices are allowed to fluctuate—go up and down

•Soc—govt can control prices or may set wage rates

Differences between Free Enterprise & Socialism cont.

Private Property

•F.E.—Private property is sacred—the belief is that if you own something you will take better care of it than if it is community owned.

•Soc—believe those who own property end up having more political power

•If gov’t owns property they will make sure it is used to benefit many instead of a few!

Mixed Economies

Mixed •An economy that is neither purely capitalist nor purely socialist.

•Most countries in the world have mixed economies

•The U.S. has a free enterprise economic system, but controls some prices!

Index of Economic Freedom

1.005.00More Economic Freedom Less Economic Freedom

Source: 2005 Index of Economic Freedom

Rank Country Score1 Hong Kong 1.35

5 Ireland 1.70

10 Australia 1.79

12 U.S.A. 1.85

16 Canada 1.91

26 Italy 2.28

39 Japan 2.46

44 France 2.63

45 South Korea 2.64

63 Mexico 2.89

71 Thailand 2.98

90 Brazil 3.25

103 Egypt 3.38

112 China 3.46

118 India 3.53

124 Russia 3.56

137 Vietnam 3.83

149 Cuba 4.29

155 North Korea 5.00

(Do not copy the chart):

1. Which country has the most economic freedom? The least?

2. What rank is the United States?

3. Do any of the rankings and scores surprise you? Why?

Mixed Economy No system in the world is PURE

Mixed Economy Economic system that incorporates elements of different systems (usually command and market)

Example: United States Market Malls, restaurants, entrepreneurship Command Minimum wage, labor laws Traditional “blue laws”, Chick Fil-A

Mixed Economies All economies are mixed; they are

classified based on how much the government is involved in the process

Some government involvement through mandatory laws and regulations that businesses follow Labor Laws, Minimum Wage

The government provides social programs for those who need help Medicare, welfare

Continuum of Mixed Economies

Centrally planned Free market

Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick

Iran

North Korea

Cuba

China

Russia Greece Peru United States

South Africa France United Kingdom

Botswana Canada Singapore

Hong Kong

Traditional Economies

Traditional •An economic system in which the answers to the 3 economic questions are based on customs, traditions, & cultural beliefs.

•Ex: Feudal System in Western Europe—all the land owned by a king. King grants lands to nobles who then grant land to peasants.

•Few traditional economies exist today

Traditional Economies—Modern Day Example

•The Hadza of Tanzania are a nomadic hunting culture, without a fixed location or many material possessions.

•Fewer than 1,000 remain today

•Their traditional economy is based on thousands of years of life in the same region, hunting the same animals.

•They build no permanent shelters, have no chieftains, and no economic system!

Review—True or False1. A traditional economic system uses customs,

traditions, and beliefs to answer the 3 economic questions.

2. The 2 dominant economic systems are traditional and free enterprise.

3. Our economic vision is our sense of how the world works.

4. A socialist thinks price should be set and controlled by the government.

5. All nations must answer 3 basic economic questions.

Review—True or False1. A traditional economic system uses customs,

traditions, and beliefs to answer the 3 economic questions.

TRUE

2. The 2 dominant economic systems are traditional and free enterprise.

FALSE

3. Our economic vision is our sense of how the world works.

TRUE

4. A socialist thinks price should be set and controlled by the government.

TRUE

5. All nations must answer 3 basic economic questions. TRUE