“Introduction to Economic Systems”Critical QuestionsCritical 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?What is an economic system?

The method used by a The method used by a society to produce and society to produce and distribute goods and distribute goods and

servicesservices

The Three Questions that Determine

a Societies Economic SystemBecause 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 An economic system is the method used by a society to produce and distribute goods and services.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

Economic System

• Traditional

• Market

• Command

• Mixed

Who answers the 3 ?’s

• Customs

• Individuals

• Central Government

• Individuals with some government involvement

Traditional SystemTraditional System• A traditional system relies on habit, A traditional system relies on habit,

custom or ritual to decide what to custom or ritual to decide what to produce, how to produce it and to produce, how to produce it and to who to distribute it.who to distribute it.

• Agricultural and hunting societiesAgricultural 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.

Traditional Economy• Found in rural, under-

developed countries– – Vanuatu

– Pygmies of Congo

– Eskimos & Indian tribes – Belarus

• 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 A market market is is an an arrangemenarrangement that allows t that allows buyers and buyers and sellers to sellers to exchange exchange goods and goods and servicesservices.

SpecializationSpecialization is the is the concentration concentration of the of the productive productive efforts of efforts of individuals individuals and firms on a and firms on a limited limited number of number of activities.activities.

Why Do Markets Exist?

Free Markets

monetary flow

physical flow

monetary flow

physical flow

Circular Flow Diagram of a Market Economy

Households Firms

• In a free market In a free market economy, households economy, households and business firms use and business firms use markets to exchange markets to exchange money and money and products. products.

• Households Households own the factors own the factors of production of production and consume and consume goods and services.goods and services.

Advantages of the MarketEconomic Efficiency

• As a self-regulating system, a free market economy is efficient.

Economic Growth• Because

competition encourages innovation, free markets encourage growth.

Economic Freedom• Free market economies

have the highest degree of economic freedom of any economic system.

Additional Goals• 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.

Command Economies

The government,or

central authority controls the economy.

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.

Organization of Command Economies

Command Economy• The government (or central

authority) determines what, how, and for whom goods and services are produced.

• Two types: – 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)

• Advantages– Guarantees equal standard

of living for everyone – Less crime and poverty– Needs are provided for

through the government• Disadvantages

– Minimal choices– Fewer choices of items – No incentive to produce

better product or engage in entrepreneurship

• Also known as a Planned or Managed Economy

The Soviet ExperimentThe 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 FlagThe 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

Mixed Economies

•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.

Mixed Economy• 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

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

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