Economic Systems and Decision Making

1. Economic Systems and Decision Making

2. Economic Systems Economic System: A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem Economic systems differ in two factors: Who owns the factors of production The method used to motivate, coordinate and direct economic activity

3. Traditional, Command, and MarketEconomies Traditional Economies: Based on custom and tradition Allocate resources and regulate economic activity through ritual, habit, and social behavior For most people, their roles are defined by accidents of birth (family, gender, etc.) Examples: Australian Aborigines, Inuits

4. Traditional, Command, and MarketEconomies Advantages of Traditional Economies Everyone knows what to do Very little insecurity about what to produce, how to produce it, and for whom something is produced Disadvantages No progress Discourages innovation Lower living standards

5. Traditional, Command, and MarketEconomies Command Economies A central authority makes most of the decisions about what to produce, how to produce it, and for whom to produce it Idea is that centralizing industries should lead to economies of scale, and ultimately make everything cheaper and more abundant than in a free market system Examples: North Korea, Cuba, former Soviet Union

6. Traditional, Command, and MarketEconomies Advantages of Command Economies Capable of extremely rapid (if also extremely painful) economic change Public services like health care, education, etc. are costs borne by the state Disadvantages Unresponsive to consumers Lack of incentives to work hard Requires a giant bureaucracy Very little flexibility

7. Traditional, Command, and MarketEconomies Market Economies Private actors pursue their own self-interest to determine what to produce, how to produce it, and for whom to produce it Individual purchasing decisions act as votes Examples: United States, Japan, Germany, Great Britain (honestly this is pretty much everyone at this point)

8. Traditional, Command, and MarketEconomies Advantages of Market Economies Can adjust to change over time High degree of individual freedom Relatively small degree of government interference Decision making is decentralized, and so more responsive and usually more accurate Incredible amount of variety of goods and services Consumer-oriented, and therefore people-oriented

9. Traditional, Command, and MarketEconomies Disadvantages of Market Economies A pure laissez-faire system does not provide for the basic needs of everyone in society Cannot provide public services effectively: justice system national defense universal education comprehensive health care High degree of uncertainty/instability

10. Traditional, Command, and MarketEconomies Disadvantages of Market Economies (cont’d) Market failures can occur if any of the following conditions do not exist: Markets must be reasonably competitive Resources must be free to move from one activity to another Consumers need access to enough information to make an informed decision (when I have better information than you do, and use that to my advantage and your disadvantage, we have asymmetrical information)

11. Characteristics of the Market System private property freedom of enterprise/choice self-interest competition markets and prices technology and capital goods specialization use of money active, but limited, government