“Introduction to Economic Systems” Critical Questions
What key economic questions must every society answer?
What basic economic goals do societies have?
What types of economic systems exist today?
What is an economic system? The method used by a society to produce and distribute goods and services
The Three Questions that Determine a Societies Economic System
Because ALL economic resources are scarce, every society must answer three questions:
What goods and services should be produced?
Guns or butter?
How should these goods and services be produced?
What combination of factor resources should we use?
Who consumes these goods and services?
How will income be distributed?
Every society has some system or mechanism that transforms that society’s scarce resources into useful goods and services.
An economic system is the method used by a society to produce and distribute goods and services.
Four Economic Systems Traditional economies rely on habit, custom, or ritual to decide what to produce, how to produce it, and to whom to distribute it. In a centrally planned economy the central government makes all decisions about the production and consumption of goods and services. In a market economy economic decisions are made by individuals and are based on exchange, or trade. Mixed economies are systems that combine tradition and the free market with limited government intervention.
Comparing Economic Systems
Who answers the 3 ?’s
Individuals with some government involvement
A traditional system relies on habit, custom or ritual to decide what to produce, how to produce it and to who to distribute it.
Agricultural and hunting societies
There is little room for innovation or change.
They tend to lack modern conveniences and have a low standard of living.
Close knit communities with focus on the family unit.
Found in rural, under-developed countries–
Pygmies of Congo
Eskimos & Indian tribes
Customs govern the economic decisions that are made
Farming, hunting and gathering are done the same way as the generation before
Economic activities are centered around the family or ethnic unit
Men and women are given different economic roles and tasks
Advantages: people have specific roles; security in the way things are done
Disadvantages : Technology is not used; difficult to improve
Markets exist because none of us produces all the goods and services we require to satisfy our needs and wants. A market is an arrangement that allows buyers and sellers to exchange goods and services . Specialization is the concentration of the productive efforts of individuals and firms on a limited number of activities. Why Do Markets Exist?
In a free market economy, households and business firms use markets to exchange money and products.
Households own the factors of production and consume goods and services.
monetary flow physical flow monetary flow physical flow Circular Flow Diagram of a Market Economy Households Firms
Advantages of the Market
As a self-regulating system, a free market economy is efficient.
Because competition encourages innovation, free markets encourage growth.
Free market economies have the highest degree of economic freedom of any economic system.
Free markets offer a wider variety of goods and services than any other economic system.
Market Economy (Free Enterprise)
Also called a Free Market Economy or Free Enterprise Economy
Businesses and consumers decide what they will produce and purchase and in what quantities
Decisions are made according to law of supply & demand
Supply and demand of goods and services determine what is produced and the price that will be charged .
Advantage—competition to have the best products and services
Disadvantage—huge rift between wealthy and poor
Note: a true market economy does not exist.
central authority controls the economy.
Organization of Command Economies In a command economy , the government owns both land and capital. The government decides what to produce, how much to produce, and how much to charge. Socialism is a social and political philosophy based on the belief that democratic means should be used to distribute wealth evenly throughout a society. Communism is a political system characterized by a centrally planned economy with all economic and political power resting in the hands of the government. Communist governments are authoritarian in nature.
The government (or central authority) determines what, how, and for whom goods and services are produced.
Strong Command – where government makes all decisions (communism – China, Cuba )
Moderate Command – where some form of private enterprise exists but the state owns major resources (socialism – France and Sweden )
Guarantees equal standard of living for everyone
Less crime and poverty
Needs are provided for through the government
Fewer choices of items
No incentive to produce better product or engage in entrepreneurship
Also known as a Planned or Managed Economy
The Soviet Experiment
Land, labor and capital was all controlled by the state. The best resources were allocated to to the armed forces, space program, and production of capital goods.
Government committees decided the quantity, process and distribution of all products.
The government created large state-owned farms and collectives to produce all agricultural products.
Under this system there was little incentive to produce, and the Soviet Union saw a rapid decline in the production of agricultural goods.
The Meaning Behind the Flag
The hammer and sickle originate from the unique Russian unity of the peasants (the sickle) with the workers (the hammer) who together formed the Soviet Russian state.
The Red field is symbolism of the blood that has been spilt by workers the world over in the fight for their emancipation.
The single yellow star is the representation of the life and immense energy of the sun, empty because within is the blood or production of workers struggle.
Command economy face problems of poor-quality goods, shortages, and diminishing production.
Other Problems in Centrally Planned Economies
Performance falls short of the set ideals
Fail to meet consumer needs and wants
Little individual incentives to work hard
Lack of improvement
Expensive and inflexible government structure needed to manage the system
Sacrifice of individual freedoms to pursue societal goals
It is doubtable that any nation can exist successfully under a pure command economy or a pure market economy.
Most economies mix features of both systems.
Combination of a market and a command economy
Government takes of people’s needs
Marketplace takes care of people’s wants.
Most nations have a mixed economy: United States, England, Australia
Advantage —balance of needs and wants met by government and in marketplace
Disadvantage —citizens have to pay taxes
An economic system that permits the conduct of business with minimal government intervention is called free enterprise . The degree of government involvement in the economy varies among nations. Nations are placed on a continuum (a range with no clear divisions) of mixed economies. On one end are centrally planned economies and on the opposite end are free markets economies. Comparing Mixed Economies 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