1 Economics Lecture 4 2007 Economics Dept Mr Lim Peng Yeow.
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Transcript of 1 Economics Lecture 4 2007 Economics Dept Mr Lim Peng Yeow.
1
Economics Lecture Economics Lecture 4 4
Economics Lecture Economics Lecture 4 4
2007 Economics Dept2007 Economics DeptMr Lim Peng YeowMr Lim Peng Yeow
2
Self-Discovery Slides
• Types of Economic Systems• What is Free Enterprise
(market system)?• How does it work?
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Types of Economic Systems
GovernmentMarket forces
CentrallyPlanned
FreeEnterprise
Mixed
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ECONOMIC SYSTEMS: free-market economy
• Free enterprise / free-market economy
- an economy where all economic decisions are taken by individual households and firms and with no government intervention
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ECONOMIC SYSTEMS: free-market economy
• Main features of the free enterprisePrivate ownership of all resourcesLimited ownership by governmentFreedom of choice
– consumer sovereigntyconsumers’ willingness and ability to pay high prices resources allocated into the production of this good
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Freedom of choice – free enterprise for producers
•governed by profit motive producers can sell what they want to
– free mobility of resources•governed by returns factor owners are free to sell their factors anywhere
ECONOMIC SYSTEMS: free-market economy
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Economic Freedomabsence of obstacles to effective choices
Freedom ofConsumer Choice
Freedom of Enterprise
• acquire any resource
• use any technology
• produce any product
• charge at any price
• invest their profits• buy any product • accept any job
• quit any job
Households Firms
Consumers Workers
Freedom ofChoice of Jobs
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Motivated by self interest– consumers - maximum satisfaction– producers - maximum profits– factor owners - maximum returns
(rent, wages, interest)
ECONOMIC SYSTEMS: free-market economy
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Existence of competition– large numbers of buyers and sellers – free flow of information – little or no advertising– free entry and exit of firms
ECONOMIC SYSTEMS: free-market economy
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• Meaning of price mechanism the system in a market economy
whereby changes in price in response to changes in demand and supply have the effect of making demand equal to supply
ECONOMIC SYSTEMS: free-market economy
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• Price mechanismdetermines the allocation of
resources within the economyworks through interaction of
demand & supply and price signalsprices measure the value of goods
and services measured in terms of standard monetary unit
ECONOMIC SYSTEMS: free-market economy
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PRICE MECHANISM
Prices on Factor MktsPrices on Factor Mkts(wages, rents, interest)(wages, rents, interest)Prices on Factor MktsPrices on Factor Mkts(wages, rents, interest)(wages, rents, interest)
HouseholdsHouseholdsHouseholdsHouseholds FirmsFirmsFirmsFirms
Prices on Goods MktsPrices on Goods MktsPrices on Goods MktsPrices on Goods Mkts
Demand g & s
Supply fop
WHAT? WHAT? HOW?HOW?
FOR WHOM?FOR WHOM?
WHAT? WHAT? HOW?HOW?
FOR WHOM?FOR WHOM?
Supply g & s
Demand fop
Factor income
Consumers’ expdt
Firms’ expdt
Firms’ rev.
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What to produce? Consumer sovereignty: Consumers, through their money “votes”, dictate what goods should be produced.
Demand for cars
Price of cars
Profits of car manufacturers
Firms will want to supply more cars
Firms pay more to attract workers & other fops
Workers & other fops move away from other industries into the auto industry
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How to produce?• Firms will choose the method of
production which minimises the cost of production.
• Hence, if the price of one resource is high relative to its productivity, producers will try to substitute a cheaper input for a more expensive one.
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For whom to produce?
Since the demand for a good must be effective, i.e. backed by the ability to pay, goods will be produced for those who have the purchasing power (higher income).
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• Advantages of a free-market economyfunctions automatically - no need for
costly and complex bureaucracies to co-ordinate economic decisions
highly competitive market - more responsive to consumer wishes
efficient use of resources (what, how, how much and for whom to produce)
ECONOMIC SYSTEMS: free-market economy
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• Problems of a free-market economy competition between firms is often
limited - a few large firmslack of competition and high profits
- little incentive for firms to be efficientunequal distribution of power and
propertyignore external costs of productionno production of public goods
ECONOMIC SYSTEMS: free-market economy
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• Problems of a free-market economymacroeconomic instability - periods of
recession with high unemployment and falling output, and other periods of rising prices
by rewarding self-interest - may encourage selfishness, greed, materialism and acquisition of power
ECONOMIC SYSTEMS: free-market economy
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Features of the 3 Economic Systems
Free Enterprise
System
Centrally Planned
Economy
Mixed Economy
Alternative Names
• Laissez-faire
• Capitalist system
• Command economy
• Planned economy
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Features of the 3 Economic Systems
Free Enterprise
System
Centrally Planned
Economy
Mixed Economy
Examples • Hong Kong
• North Korea
• Cuba
• US
• UK
• Singapore
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Features of the 3 Economic Systems
Free Enterprise
System
Centrally Planned
Economy
Mixed Economy
Features
1. Ownership of Resources / Factors of Production (fops)
• Private ownership (i.e. by individual households & firms) of almost all fop
• Public ownership (i.e. by the state) of almost all fop
• Public & private ownership
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Features of the 3 Economic Systems
Free Enterprise
System
Centrally Planned
Economy
Mixed Economy
• Price mechanism
• Govt directives
Feature
2. How economic decisions are made
• Price mechanism & govt directives
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Features of the 3 Economic Systems
Free Enterprise
System
Centrally Planned
Economy
Mixed Economy
• Self-interest
• For the common good of the nation
Feature
3. Dominating motive
• Self-interest & common good