2. In this chapter, you will
learn to solve these
economic puzzles:
If the SovietsAdam foolish to
were Smith
Why did drivers in the former
What did
run their economy on five-
mean when heremove the
Soviet Union said that an
year plans, why do some
windshieldhand” promotes
“invisible wipers and side
institutions in a capitalistic
mirrors whenever they
the public interest?
economy plan?
parked their cars?
2
3. What is an
Economic System?
The organization and
methods used to determine
what goods and services
are produced, how they are
produced, and for whom
they are produced
3
4. What are the basic types
of Economic Systems?
• Traditional
• Command
• Market
4
5. What is a
Traditional Economy?
A system that answers
the What, How, and For
Whom questions the
way they always have
been answered
5
6. What is the Benefit of a
Traditional Economy?
There is little friction
among members because
relatively little is disputed
6
7. What are the
Disadvantages of a
Traditional Economy?
Restricts individual initiative
Lack of advanced goods, new
technology, and growth
7
8. What is a
Command Economy?
A system that answers
the What, How, and For
Whom questions by
central authority
8
9. What is the Structure of a
Command Economy?
It has a pyramid structure
9
10. The Command Economy Pyramid
Supreme
planning
agency
Specialized planning agencies
Producing units
Consuming units
10
11. What are the
Strengths of a
Command Economy?
Economic change can
occur very quickly
Social welfare can be
enhanced
11
12. What are the
Weaknesses of a
Command Economy?
Decision makers have the
power to be absolutely
wrong
Quality and variety of
goods suffer
12
13. Price per side mirror (rubles) Central Planners Fixing Prices
$80 S Price set by planners
Shortage of 400
$60 thousand side mirrors
E
$40
$20
D
200 400 600 800 1000
Quantity of side mirrors (thousands per day)
13
14. Shortage of
mirrors
Planners set
the price of
mirrors below
equilibrium
14
15. What is a
Market Economy?
An economic system that
answers the What, How,
and For Whom questions
using prices determined by
the interaction of the forces
of supply and demand
15
16. Who was Adam Smith?
The father of modern
economics who
believed that a free
market economy acted
like an “invisible hand”
16
17. What is the
Invisible Hand?
A phrase that expresses the
belief that the best
interests of a society are
served when individual
consumers and producers
compete to achieve their
own private interests
17
18. What is the advantage of
a Market Economy?
It provides a wide variety of
goods and services that
buyers and sellers exchange
at the lowest prices
18
19. What are Criticisms of a
Market Economy?
• Lack of competition
• Externalities
• Lack of public goods
• Income inequality
19
20. What is a
Mixed Economy?
An economic system that
answers the What, How,
and For Whom questions
through a mixture of
traditional, command,
and market systems
20
21. What is Capitalism?
An economic system
characterized by
private ownership of
resources and markets
21
22. What is
Consumer Sovereignty?
The freedom of consumers
to cast their dollar votes
to buy, or not to buy, at
prices determined in
competitive markets
22
23. What is Communism?
A stateless, classless
economic system in
which all the factors of
production are owned by
the workers and people
share in production
according to their needs
23
24. Who was Karl Marx?
His criticism of capitalism
advanced communism
24
25. What is Socialism?
An economic system
characterized by
government ownership of
resources and centralized
decision making
25
27. What are the Strengths
of Socialism?
• An equitable distribution
of income
• Rapid growth is possible
• No unemployment
27
28. What are the
Weaknesses of Socialism?
Inefficiencies occur
Absence of entrepreneurship
stifles growth
28
29. A Classification of Economic Systems
U.S., Canada,
Cuba China, former
Soviet Union Western Europe
Pure Pure
socialism capitalism
France, Mexico, Hong Kong
Sweden, Latin
Israel America,
Japan
29
31. Key Concepts
• What is an Economic System?
• What are the basic types of Economic System
• What is a Traditional Economy?
• What is a Command Economy?
• What is a Market Economy?
• Who was Adam Smith?
31
32. Key Concepts cont.
• What is the Invisible Hand?
• What is a Mixed Economy?
• What is Capitalism?
• What is Communism?
• Who was Karl Marx?
• What is Socialism?
32
34. An economic system is the set
of established procedures by which
a society answers the What, How
and For Whom to produce question.
34
35. Three basic types of economic
systems are the traditional, command,
and market systems. The traditional
system is based on decisions made
according to custom, and the command
system answers the three economic
questions through some powerful central
authority. In contrast, the market system
uses the impersonal mechanism of the
interaction of buyers and sellers through
markets to answer the What, How, and
For Whom questions.
35
36. The Command Economy Pyramid
Supreme
planning
agency
Specialized planning agencies
Producing units
Consuming units
36
37. Capitalism is an economic
system in which the factors of
production are privately owned and
economic choices are made by
consumers and firms in markets. As
prescribed by Adam Smith, there is
an extremely limited role for
government, and self-interest is the
driving force, held in check, or
regulated, by competition.
37
38. Consumer sovereignty is the
determination by consumers of the
types and quantities of products that
are produced in an economy.
38
39. Socialism is an economic system
in which the government owns the
factors of production. The central
authorities make the myriad of
society’s economic decisions
according to a national plan. The
collective good, or public interest, is
the intended guiding force behind the
central planners’ decisions.
39
40. Communism is an economic
system envisioned by Karl Marx to be
an ideal society in which the workers
own all the factors of production.
Marx believed that workers who
worked hard would be public spirited
and would voluntarily redistribute
income to those who are less
productive. Such a communist nation
described by Marx does not exist.
40
42. 1. The economic system in which all of the basic
decisions are made through a centralized
authority, such as a government agency, is
termed a
a. market economy.
b. capitalistic economy.
c. command economy.
d. traditional economy.
C. To answer the three basic economic questions,
the market economy uses the price system and a
traditional economy is based on customs.
42
43. 2. Command economies typically suffer from
a. unemployment, but not underemployment.
b. neither unemployment nor
underemployment.
c. both unemployment and underemployment.
d. underemployment, but not unemployment.
D. Command economies assign people jobs
rather than allow the market system to
determine wages and employment.
43
44. 3. Adam Smith stated that the role of
government in society should be to
a. provide defense.
b. enforce contracts.
c. do absolutely nothing.
d. both (a) and (b).
D. Adam Smith believed in a limited role of
the government to provide national defense,
education, maintain infrastructure, enforce
contracts, and little else.
44
45. 4. When making economic decisions, Adam
Smith urged society to
a. follow the principle of self-interest.
b. follow the principle of public interest.
c. transfer wealth according to need.
d. provide equal income for all citizens.
A. Adam Smith stated “By pursuing his own
interest he frequently promotes that of the
society more effectively than when he really
intends to promote it.”
45
46. 5. The doctrine of laissez faire
a. advocates an economic system with
extensive government intervention and little
individual decision-making.
b. was advocated by Adam Smith in his book
The Wealth of Nations.
c. was advocated by Karl Marx in his book Das
Kapital.
d. none of the above.
B. Laissez faire is a French expression
meaning “allow them to act” stated
differently, “The least government is the
best government.”
46
47. 6. In Adam Smith’s competitive market economy,
the question of what goods to produce is
determined by the
a. “invisible hand” of the price system.
b. “invisible hand” of government.
c. “visible hand” of public interest.
d. “visible hand” of laws and regulations.
A. The “invisible hand” refers to a system
where no central authority makes the key
economic decisions, but rather decisions
are make collectively by all consumers and
producers in the economy.
47
48. 7. Adam Smith wrote that the
a. economic problems of the 18th-century
England were caused by free markets.
b. government should control the economy
with an “invisible hand.”
c. pursuit of private self-interest promotes the
public interest in a market economy.
d. public or collective interest is not promoted
by people pursuing their self-interest.
C. Adam Smith recognized that everyone
making decisions based on their own self
interest would enhance the public interest.
48
49. 8. Adam Smith, in his book The Wealth of
Nations, advocated
a. socialism.
b. an economy guided by an “invisible
hand.”
c. government control of the “invisible
hand.”
d. the adoption of mercantilism.
B. Adam Smith advocated a laissez faire
stance by government. That is, the
government should provide the foundation
for a free market system, but should not be
a major participant in answering the
questions of What, How, and for Whom.
49
50. 9. The economic system in which private
individuals own the factors of production is
a. a planned economy.
b. capitalism.
c. collectivism.
d. socialism.
B. For answers a,c, d, resources or factors of
production are owned by the government.
50
51. 10. Which of the following is not a basic
characteristic of capitalism?
a. Economic decisions occur in markets.
b. Factors of production are privately
owned.
c. Income is distributed on the basis of need.
d. Businesses make their own product and
price decisions.
C. Karl Marx believed people would be
motivated by the principle “from each
according to his ability, to each
according to his need.”
51
52. 11. According to Karl Marx, under capitalism,
a. profits would be shared fairly.
b. incomes would be distributed equally.
c. workers would be exploited and revolt
against owners of capital.
d. workers would actually own the factors of
production.
C. Karl Marx believed that private
ownership and profits lead to exploitation.
The result is a class struggle between a few
“haves” and “havenots.”
52
53. 12. Karl Marx predicted which of the
following?
a. market system would self destruct.
b. “haves” would revolt against the “have-
nots.”
c. wealthy were entitled to profits as their
reward for risk-taking.
d. none of the above.
A. Karl Marx argued the market system
would destroy itself because owners would
go too far and pay starvation wages in order
to maximize profits.
53
54. 13. How many nations in the world today
operate totally according to Karl Marx’s
theory of communism?
a. None.
b. Several.
c. Only the United States.
d. Many.
A. Under Marx’s idealized society of
communism, people would distribute
wealth according to need and no central
authority would be necessary.
54
55. 14. In Marx’s ideal communist society, the
state
a. actively promotes income equality.
b. follows the doctrine of laissez faire.
c. owns resources and conducts planning.
d. does not exist.
D. Under Marx’s idealized society of
communism, individuals with ability
would distribute the wealth of society
according to each person’s need.
55
56. 15. Karl Marx was a (an)
a. 19th-century German philosopher.
b. 18th-century Russian economist.
c. 14th-century Polish banker.
d. 19th-century Russian journalist.
A. Karl Marx was born in Germany, the
son of a lawyer. Marx was an
outstanding student at Berlin
University. In 1841, after receiving a
doctorate in philosophy, he turned to
journalism.
56
57. Internet Exercises
Click on the picture of the book,
choose updates by chapter for
the latest internet exercises
57
