2.1 Economic Questions and Objectives Economic Systemsmyfinanceclass.com/files/69159927.pdf · 2.1...

CONTEMPORARY ECONOMICS © Thomson South-Western

Objectives2.1 Economic Questions and Economic Systems

Identify the three questions that all economic systems must answer.

Describe a pure market economy, and identify its problems.

Describe a pure command economy, and identify its problems.

Compare mixed, transitional, and traditional economies.

Objectives


economic system pure market economy pure command economy mixed economy market economy transitional economy traditional economy

Key Terms

2.1 Economic Questions and Economic Systems


2.1 Economic Questions and Economic Systems SLIDE3

The Three Economic QuestionsAll economies must answer three questions: 1. What goods and services will be

produced?2. How will they be produced? 3. For whom will they be produced?



Economic System An economic system is the set of mechanisms

and institutions that resolves the what, how, and for whom questions.

Some standards used to distinguish among economic systems are:Who owns the resources?What decision-making process is used to allocate

resources and products?What types of incentives guide economic decision

makers?



Pure Market EconomyAll resources are privately owned.Coordination of economic activity is based

on the prices generated in free, competitive markets. Any income derived from selling resources

goes exclusively to each resource owner.



Invisible Hand of MarketsAccording to Adam Smith (1723–1790),

market forces coordinate production as if by an “invisible hand.”


2.1 Economic Questions and Economic Systems SLIDE7Problems with

Pure Market EconomiesDifficulty enforcing property rightsSome people have few resources to sellSome firms try to monopolize marketsNo public goodsExternalities



Pure Command EconomyAll resources government-ownedProduction coordinated by the central

plans of government officialsSometimes called communism


2.1 Economic Questions and Economic Systems SLIDE9The Visible Hand

of Central PlannersCentral planners direct the allocation of

resources and productsControl resourcesDirect productionAllocate products


2.1 Economic Questions and Economic Systems SLIDE10Problems with

Command EconomiesConsumers get low priorityLittle freedom of choiceCentral planning can be inefficientResources owned by the central authority

are sometimes wastedEnvironmental damage



Mixed EconomyUnited States is a mixed economy.Because markets play a relatively large

role, it is considered a market economy.Government regulates the private sector in

a variety of ways.



Transitional EconomyA transitional economy is in the process

of shifting orientation from a command economy to a market economy.This transition involves converting

government enterprises into private enterprises—privatization.The transition now under way will shape

economies for decades to come.



Traditional Economy A traditional economy is shaped largely

by custom or religion.Family relations also play significant roles

in economic activity.


2.2 Production Possibilities Frontier

Describe the production possibilities frontier, and explain its shape.

Explain what causes the production possibilities frontier to shift.

Objectives


2.2 ProductionPossibilities Frontier

production possibilities frontier (PPF)efficiency law of increasing opportunity costeconomic growth

Key Terms


2.2 Production Possibilities Frontier SLIDE3Efficiency and Production

Possibilities FrontierSimplifying assumptionsPPF model Inefficient and unattainable productionShape of the PPF


2.2 Production Possibilities Frontier SLIDE4

Production Possibilities Frontier A through F are

attainable I represents

inefficient use of resources

U represents unattainable combinations

Figure 2.1



Shifts in the PPFChanges in resource availability Increases in stock of capital goodsTechnological change Lessons from the PPF



Shifts in the PPFIncrease in

Available ResourcesDecrease in

Available Resources

Figure 2.2


2.3 Comparative Advantage

Explain the law of comparative advantage.

Understand the gains from specialization and exchange.

Objectives


2.3 Comparative Advantage

absolute advantage law of comparative advantagespecializationbartermoneydivision of labor

Key Terms


2.3 Comparative Advantage SLIDE3

Comparative Advantage Absolute advantage—to be able to make

something using fewer resources than other producers require

Law of comparative advantage—the worker, firm, region, or country with the lowest opportunity cost of producing an output should specialize in that outputSpecialization—occurs when individual workers

focus on single tasks, enabling each one to be more efficient and productive



Gains from SpecializationAbsolute advantage focuses on which of

you uses the fewest resources, but comparative advantage focuses on what else those resources could have produced—that is, on the opportunity cost of those resources. The law of comparative advantage

indicates who should do what.



ExchangeBarter—a system of exchange in which

products are traded directly for other productsMoney—anything that everyone is willing

to accept in exchange for goods and services



Wider ApplicationResources are allocated most efficiently

across the country and around the world when production and trade conform to the law of comparative advantage.



SpecializationBecause of specialization based on

comparative advantage, most people consume little of what they produce and produce little of what they consume.Division of labor sorts the production

process into separate tasks to be carried out by separate workers.



Division of LaborTakes advantage of individual preferences

and natural abilities Allows workers to develop more

experience at a particular task Reduces the time required to shift

between different tasks Permits the introduction of labor-saving

machinery


2.3 Comparative Advantage SLIDE9Specialization that Results with

Division of LaborDoes not occur among individuals only Also occurs among firms, regions, and

entire countries

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