Chapter 2Economic Systems, Resource

Allocation, and Social Well-Being: Lessons From China’s Transition

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Economic Systems

• Pure Market Economy Private property rights Decentralized decision making coordinated

through markets

• Pure Command Economy State ownership and/or control of economic

resources Centralized planning

• Mixed Systems Transitional economy

2-2

Resource Allocation in aMarket Economy

• Market Structure Purely Competitive Markets

Large number of buyers and sellers Each seller offers standardized product Product prices free to move up or down Buyers and sellers must be mobile Freedom of entry and exit

Purely Monopolistic Markets One seller

Imperfectly Competitive Markets

2-3

Demand

5 10 15 20

.50

1.00

1.50

2.00

2.50

3.00

Price$

Quantity

Price ($)

Quantity (Six-

Packs per

Week)

$1.50 1,500

2.00 1,00

2.50 500

D

D

• Law of Demand

• Other Things Being Equal

2-4

Quantity Demanded versus Demand

5 10 15 20

.50

1.00

1.50

2.00

2.50

3.00

Quantity

D

D

D2

D2

D1

D1

•Consumer Income•Prices of Related Goods

•Substitutes•Complements

•Tastes•Expectations•Number of Consumers

Price $

2-5

Supply

250 500 750 20

5

10

15

20

Quantity

Price ($)

Quantity (Cars per

year)

$5,000 250,000

10,000 500,000

15,000 750,000

S

S

Price $

2-6

Quantity Supplied versus Supply

250 500 750 20

5

10

15

20

Quantity

S

S

S1

S1

S2

S2

•Cost of Production•Prices of Related Goods•Seller’s Expectations•Number of Sellers

Price $

2-7

Equilibrium

5 6 7 8 9 10

5

6

7

8

9

Price $

Quantity

3

4

D

D S

S

Surplus

Shortage

2-8

Resource Allocationin a Command Economy

• Centralized Planning The Communist Revolution in China Establishment of a Command Economy

• Problems with Centralized Planning Initial Phase Great Leap Forward

State Planning Commission Cultural Revolution

2-9

Shortcomings of Central Planning

• Informational Requirements

• Incentives for Efficient Production

• Heavy Industry versus Consumer Goods

2-10

China’s Transition to aMarket-Oriented Economy

• Agricultural Reform

• Industrial Reform

• Lessons for Other Economies

2-11

China’s Transition to Markets: What Are the Facts?

China’s Comparative Economic Performance Since Reform

Real GDP Crop Production

China 8.92% China 6.45%

South Korea 3.31 South Korea 0.05

Singapore 7.66 Singapore 10.55

Vietnam 7.53 Vietnam 4.63

Low-income 4.68 Low-income 4.10

United States 2.57 United States 1.52

Real Per Capita GDP Industrial Production

China 8.00% China 11.42%

South Korea 2.38 South Korea 5.13

Singapore 6.65 Singapore 8.50

Vietnam 6.43 Vietnam 10.29

Low-income 2.53 Low-income 5.76

United States 1.61 United States 0.76 2-12

Problems of Transition in China

• Unemployment and inflation

• Corruption

• Population pressures

• Pollution problems

• The desire for democracy

2-13