Economics SystemsCORA HODGINS

The fundamental economic problem in any society is to provide a set of rules for allocating resources and/or consumption among individuals who can't satisfy their wants, given limited resources.

In every nation, no matter what the form of government, what the type of economic system, who controls the government, or how rich or poor the country is, three basic economic questions must be answered. They are:

What and how much will be produced? Literally, billions of different outputs could be produced with society's scarce

resources.

(Scarcity- In economics, scarcity is the problem of infinite human needs and wants, in a world of finite resources.

In other words, society does not have sufficient productive resources to fulfill those wants and needs

How will it be produced? There are many ways to produce a desired item.

It may be possible to use more labor and less capital, or vice versa.

It may be possible to use more unskilled labor to substitute for fewer units of skilled labor.

For whom will it be produced? Once a commodity is produced, some mechanism must exist that distributes

finished products to the ultimate consumers of the product.

The mechanism of distribution for these commodities differs by economic system.

Market economy An economic system in which individuals own and operate the factors of production.

AKA: Free enterprise, Capitalism

United States, Great Britain, Japan

Market Economies¨ Economic decisions are made by the basic principals of supply and demand

¨ Profit is the motive for increasing work rather than quotas

Market Economies¨ Also called capitalist economies

¨ There are many economic freedoms

¨ There is competition among businesses

¨ Competition determines price which increase the quality of the product

Command economy

An economic system in which the government owns and operates the factors of production.

AKA: Socialism, Communism

Cuba, China, Laos, North Korea

Command Economies¨ The government or other central authority makes decisions and determines

how resources will be used

¨ Change can occur relatively easily

¨ There is little individual freedom

¨ There is no competition

¨ Businesses are not run to create a profit

Command Economies¨ Consumers have few choices in the market place

¨ Factories are concerned with quotas

¨ Shortages are common because of poorly run factories and farms

¨ The government dictates the job in which you work

¨ The government sets the prices of goods and services

Traditional economy

¨ An economic system based upon customs and traditions. Economy is based upon agriculture and hunting.

¨ Traditional economies are found in rural, non-developed countries

¨ Some parts of Asia, Africa, South America and the Middle East have traditional economies

¨ Customs govern the economic decisions that are made

¨ Technology is not used in traditional economies.

AKA: Non-Industrialized, Agrarian societies

Chad, Haiti, Rwanda

Traditional economy

¨ Farming, hunting and gathering are done the same way as the generation before

¨ Economic activities are usually centered toward the family or ethnic unit

¨ Men and Women are given different economic roles and tasks

Mixed economy

An economic system that has features of both market and command economies.

Mixed Economies¨ Government and individuals share the decision making process

¨ Government guides and regulates production of goods and services offered

¨ Individuals own means of production

¨ Protects consumers and workers from unfair policies

¨ Most effective economy for providing goods and services

In reality there are no pure market economies, nor are there any pure command economies. For example, even in the United States, where free enterprise reigns, the government plays a major role in the economy. Minimum wages, social security, and regulatory policies are examples of government involvement.

In China, for example, some private ownership of businesses is allowed, however the government still maintains tight control over the factors of production and prices.

While we could say that both the United States and China are mixed economies because they contain both market and command economic features, to do so would be misleading because the role that the respective governments play in the economy are quite different.

The Differences Between Market and Command Economies

Gross domestic product (GDP) is one of the measures of national income and

output for a given country's economy. GDP is defined as the total market value of all final goods and services produced within the country in a given period of time (usually a calendar year).

Map of countries by 2007 GDP (nominal) per capita (IMF, April 2008).

Factors of Production

Land

Labor (Human Capital)

Capital ($$$)

Resources

Entrepreneur

Land

Land in economics includes all naturally occurring resources whose supply is inherently fixed. Such as mineral deposits.

Labor (Human Capital) In economics, labor is a measure of the

work done by human beings. There are theories which have created a

concept called human capital referring to the skills that workers possess, as in the education and training the workers have had.

Building a Workforce

How a country manages is productive resources makes a big difference in the strength of its economy.

Investing in HUMAN CAPITAL will pay off for years to come. As humans increase their knowledge they are

capable of completing more complex tasks which are more valuable to businesses.

Capital In economics, capital or capital

goods or real capital refers to items of extensive value, it can also be applied to the amount of wealth a person controls or is capable of controlling. Anything used to run a business.

Goods with the following features are capital:It can be used in the

production of other goods (this is what makes it a factor of production).

Natural resources There are 2 types of natural resources: Renewable

and Non-renewable. Natural resources include soil, timber, minerals,

and other goods taken more or less from the Earth. Both extraction of the basic resource and refining it into a purer, directly usable form, (e.g., metals, refined oils) are generally considered natural-resource activities.

A nation's natural resources often determine its wealth in the world economic system, and in determining its political influence.

In recent years, the depletion of natural resources has become a political and economic issue. This is of particular concern in rainforest regions, which hold most of the Earth's natural biodiversity. Conservation of natural resources is the major focus of natural capitalism, environmentalism, the ecology movement, and Green Parties. Some view this depletion as a major source of social unrest and conflicts in developing nations.

Pick one of the following country examples to analyze and determine if starting a business there would work, explain your theoryCountry “A” has a very skilled labor force of

college and trade school education, very few natural resources, and is in a financial depression with little capital.

Country “B” has a hard working labor force of traditional farmers, large amounts of natural resources, yet only has minimal capital for new businesses.

Country “C” has a somewhat skilled labor force of high school level education, extensive natural resources, and limited capital for new investment.

Entrepreneur

An entrepreneur is a person who has possession over a company, enterprise, or venture, and assumes significant accountability for the inherent risks and the outcome.

Trade Barriers A trade barrier is a general term that describes any

government policy or regulation that restricts international trade. The barriers can take many forms, including:

quotas

Tariffs

Embargo

Most trade barriers work on the same principle: the imposition of some sort of cost on trade that raises the price of the traded products. If two or more nations repeatedly use trade barriers against each other, then a trade war results.

Economists generally agree that trade barriers are detrimental and decrease overall economic efficiency, this can be explained by the theory of comparative advantage.

Tariffs A tariff is a tax on goods imported into a country.

from foreign competition. For example, a 50% tax on an imported machine raises the price from $100 to $150. Without a tariff, the local manufacturers could only charge $100 for the same machine; now they can charge $149 and make the sale. A "protective tariff" is intended to artificially inflate prices of imports and "protect" domestic industries

Quotas

An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time.

For example, a country might limit sugar imports to 50 tons per year. Quotas, like other trade restrictions, are used to benefit the producers of a good in a domestic economy at the expense of all consumers of the good in that economy.

Embargo An embargo is the prohibition of trade with a

certain country, in order to isolate it and to put its government into a difficult internal situation, given that the effects of the embargo are often able to make its economy suffer from the initiative.

The embargo is usually used as a political punishment for some previous disagreed policies or acts, but its economic nature frequently raises doubts about the real interests that the prohibition serves.

Specialization or Division of Labor

Each person specializes in one occupation, to become the best at that job as possible, while others do the same with other occupations.

Basically, it's a working society that does many different jobs.

Example: A few people farm, a few people create pottery, and a few people are blacksmiths. The society works together to make the society wealthier and more efficient.

In Plato's Republic, "Well then, how will our state supply these needs? It will need a farmer, a builder, and a weaver, and also, I think, a shoemaker and one or two others to provide for our bodily needs. So that the minimum state would consist of four or five men...." (The Republic, Page 103, Penguin Classics edition.)

Currency Exchange

Forms of Currency-Money

Shells

Precious Metals Silver

Gold

Bills or Notes Paper $ (Dollars, Peso, Euro, and so on)

Plastic Debit and Credit Cards

Foreign Exchange Market: What Is It?

To buy foreign goods or services, or to invest in other countries, companies and individuals may need to first buy the currency of the country with which they are doing business. Generally, exporters prefer to be paid in their country’s currency or in U.S. dollars, which are accepted all over the world. When Canadians buy oil from Saudi Arabia they may pay in U.S. dollars and not

in Canadian dollars or Saudi riyals, even though the United States is not involved in the transaction.

The foreign exchange market, or the "FX" market, is where the buying and selling of different currencies takes place. The price of one currency in terms of another is called an exchange rate.

Currency Exchange

Most common contact with foreign exchange occurs when we travel or buy things in other countries.

Suppose a U.S. tourist travelling in London wants to buy a sweater. Price tag is 100 pounds (Symbol for pounds: £).

Current exchange rate Price of sweater in dollars

$1.45 to £1 100 x 1.45 = $145.00

$1.30 to £1 100 x 1.30 = $130.00

$1.60 to £1 100 x 1.60 = $160.00

$2.00 to £1 100 x 2.00 = $200.00

For businesses or governments that trade billions of dollars, even small changes in the exchange rate become significant.

How does FX affect an economy? When the United States dollar (symbol: USD)

becomes stronger, then foreign goods and services become cheaper, and goods and services from the United States will become more expensive. Consequently, imports to the United States will increase and exports will decrease.

When the dollar becomes weaker with respect to other currencies, then the opposite happens: goods and services from the United States become cheaper, thereby increasing exports, and foreign goods and services will become more expensive, thereby lessening imports.

Sources for currency demand on the FX market

The currency of a growing economy with relative stability and a wide variety of competitive goods and services will be more in demand than that of a country in political turmoil, with high inflation and few marketable exports.

For example:

News of political instability in a country drives down the demand for its currency

Currency Income- the money made for doing a job

A paycheck from the company you work for

Credit- buying something now with the promise of paying it back later Credit cards are paid at the end of the month

Savings- money set aside to be used at a late time

Investing- paying money into something in the hopes of earning a profit Stocks, people, and many other options

Protective Tariff- is intended to artificially inflate prices of imports and protect domestic industries. Slowing the influx of foreign products so that the domestic

businesses will improve.

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Bibliography

Federal Reserve of New York. http://www.ny.frb.org/education/fx/foreign.html

Retrieved March 13, 2009