Economic Systems

Economic Systems Chapter 2

market incentive firm industry circular flow model self-interest equity traditional economy command economy market economy mixed economy free-enterprise capitalism competition laissez faire Terms

How do we handle scarcity? The decisions to allocate resources are based on satisfying the greatest number of wants & needs. Every economy must answer the 3 Economic Questions 1. what to produce ? 2. how to produce ? 3. for whom to produce ?

What to produce … • each economic system decides what is most important to satisfy its wants & needs • what resources (land, labor, & capital) are available? • which are important? • what are the opportunity costs of those decisions?

How to produce … • how will the resources available be used? • which are easily utilized? • what combinations of land labor & capital are needed to produce? • are the resources being used efficiently?

For whom to produce … • who will use the product? what is the market ? • how will the products or services be distributed ? • who has the greatest need ? • who can afford the products? • how is the worth & prices of the products decided?

Economic Systems 4 types of systems address the 3 economic systems in different ways…. • Traditional economy • Command economy • Market economy • Mixed economy

Traditional Economy • answers the economic questions based on cultural traditions, habits, or rituals • relatively small communities • generally agricultural economies

Traditional Economy …. more • strong families, religious beliefs • low standard of living • little room for innovation Ex: Amish or tribal communities

Command Economy • relies on government or central planning community to answer economic questions • individuals have little or no say in economic planning • little individual freedom or choice • the government has control or owns resources Ex: Cuba, North Korea, Iran

Socialism • Not a pure Command System. • A system in which the gov’t owns basic resources; the rest are privately owned. • The government owns the basic industries, but other industries are privately owned. • Central Planners(members of the central government) make decisions for government-owned industries. • Socialism can exist in a democracy. Ex: Canada, and Sweden

Communism • A Pure Command and a more extreme form of socialism. • No private ownership of property and little or no political freedom. • Gov’ t planners decide how resources are used. • Requires absolute obedience to authority. • Prevents individuals from making profits Ex: Cuba, North Korea, former Soviet Union

Market Economy • individuals answer economic questions • individuals & businesses use the market to exchange goods & money • individuals & private businesses own & control resources

Market Economy • specialization leads to economic efficiency • more innovative & higher technology • the market is driven by self-interest Ex: United States, Canada, Hong Kong

Market Economy • also called free-enterprise or capitalism • strong sense of competition- rivalry between companies • incentives encourage individuals & businesses to behave in a certain way • businesses are motivated by profits- financial gain

The Circular Flow Model • An illustration of the interaction between households & businesses in the free market • households: owners of resources & consumers of goods & services • firms: buys resources from households produces goods & services sells products to households • Industry: firms which produce the same type of goods

Circular Flow Diagram of a Market Economy • Households pay firms for goods and services. • monetary flow • physical flow • Firms supply households with goods and services. • Households supply firms with land, labor, and capital. • Households • Firms • physical flow • Firms pay households for land, labor, and capital. • monetary flow The Circular Flow Model • Households own resources – Land, Labor, Capital • Households provide resources to firms • Firms provides products to households • Firms pay households for resources • Firms earn income • Households pay firms for products • Firms earn revenues • *monetary = money • Product market • Factor market

Mixed Economy • combines the elements of traditional, command, and market economies • the government has varying degrees of involvement: regulates business provides a safety net for those in need • all economies are actually mixed: some tend to lean toward 1 “pure” system & are classified as such

Circular Flow Diagram of a Mixed Economy • monetary flow • physical flow • taxes • government purchases • Government • expenditures • expenditures • Firms • Households • government-owned factors • taxes • physical flow • monetary flow Government’s Role in a Mixed Economy In a mixed economy, • The government purchases land, labor, and capital from households in the factor market, and • Purchases goods and services in the product market. • Expenditure = spending funds • Product market • Factor market

Adam Smith & self-interest • Adam Smith – Scottish economist in the 1700s • Wealth of Nations- written in 1776 describes how a market system can flourish • called for economic laissez faire- restricted government involvement • the market is driven by an Invisible Hand - self-interest- impulse that leads people to satisfy their own wants & needs • ultimately society benefits

Economic Systems