Economic Systems and the American EconomyChapter 2

Learning Objective• I can describe the 3 basic questions that all economics systems

attempt to answer

Three Basic Questions• Economic System• The way a nation determines how to use its resources to satisfy

its people’s needs and wants• What Should Be Produced?• How Should It Be Produced?• For Whom Should It Be Produced?

Learning Objective• I can identify advantages and disadvantages of traditional,

market, command, and mixed economic systems.

Types of Economic Systems• Traditional System • Command System• Market System• Mixed System

Traditional• Questions answered by how they have been done in past.

(often religious)• Advantages– Expectations Known– Strong Community

• Disadvantages– Change Discouraged (punished)– Inefficient Productions– Limited Consumer Choices– Little Increase in Standard of Living

Command• Government leaders control FOP and make all decisions

(single person or central group)• Disadvantages• Lack of Incentives• Limited Consumer Choices

• Advantages• Quick Changes Possible• Necessities at Little or No Cost

Market• Individuals own FOP and therefore make all decisions.• Market – Voluntary Exchange of Goods and Ideas• Prices combination between buyers and sellers. Tells what to

buy and produce.• Circular Flow of Income and Output

Market Cont.• Advantages– Freedoms

• Career• How to Spend Income• Property Ownership• Whether to Take Risks

– Lots of Choices in Goods Due to Competition– Supply and Demand determine prices

• Disadvantages– No concern over elderly, disabled, or too young to work.– Change is Gradual

Mixed• Combines elements of Pure Market and Command.• Individual decision making and private ownership ALONG

WITH government intervention and regulation.

Characteristics of the American Economy• Limited Role of Government• Freedom of Enterprise• Freedom of Choice• Profit Incentive• Competition• Private Property

Limited Role of Government• Adam Smith (1776) An Inquiry into the Nature and Causes of

the Wealth of Nations – Invisible Hand• Pure Capitalism (Market) – Laissez-Faire – Let people do as

they choose.• U.S. – Let People Own Businesses and Industries BUT Must

Operate Within Legislative Limits.

Freedom of Enterprise• Private ownership of property and businesses.• Entrepreneurship – YOU TAKE THE RISK

• Within Certain Limits However• Zoning Regulations• Child Labor Laws• Consumer Protection Agencies

Freedom of Choice• Buyers (not sellers) make decisions about what to produce• Government Intervention• Sets Safety Standards• Regulates Prices (under limited competiton)

Profit Incentive• Desire to Make a Profit• Provides motivation to improve, make better• Losses? Signal to move elsewhere.

Competition• Requires large number of independent sellers• Encourages Efficiency• Keep Prices Low to Sell

• But High Enough for Profits

• Must Keep Low Production Costs• Must have little stopping entering and exiting

Private Property• Individual right to buy property whenever you want.• Individual controls how and when to use property.• Constitution guarantees an owner’s right to private property

and its use

Goals of Free Enterprise• Economic Freedom • Efficiency• Equity • Security• Stability• Growth

Economic Freedom• Free to Make Choices• Start own Businesses• Own Private Property• Where and When to Work

• Must Accept Consequences

Economic Efficiency• Using Limited Resources Wisely• Scarcity a Problem

Economic Equity• Fairness• Lawmakers pass wage laws• Discrimination laws

Economic Security• Protection against things beyond our control• Work Related Injuries• Natural Disasters• Bank Failure• Old Age

Economic Stability• Reduce ups and downs of Standard Of Living- material well-

being of individual, group, or nation.• Measured by average value of goods and services used by

average citizen during given period of time.• We have more enjoying highest SOL than anywhere in world.

Economic Growth• Producing more goods and services over long term• Must happen WHY???

Rights and Responsibilities• Rights• Enter any job or profession you want• Can work as hard as you want• Buy what you want

• Responsibilities• Ability to support you and family• Become a productive member of Free Enterprise• Electing responsible officials:• Need knowledge of policies• Ability to analyze consequences of policies

Pure Socialism• Government manages Production and Distribution – North Korea, Cuba• Karl Marx – Bourgeoisie vs. Proletariat • Value of Goods Depends on How Much Labor Went Into Production

• Bourgeoisie used Proletariat unfairly• Used their labor then kept profits

• Capitalism was doomed to fail • Would evolve into Socialism then Communism – System with no need for

government• Irony: Today came to mean authoritarian system that supports

revolution to gain power.• Proletariat actually has little to no power

Characteristics of Pure Socialism• Prices set by State – Not by Supply and Demand• Movement or Resources (especially Labor) Controlled by

the State• Most Factors of Production Owned by the State. Private

Property Limited to Tools Needed for Occupation• Risk Taking Not Permitted. State Takes All Risks. Citizens

Share in Unsuccessful Risks.• What, How, and for Whom to Produce Made by State

Officials

4 Steps in Change to Socialism1. Extreme Recessions and Depression

- Only A Few Wealthy Would Emerge2. Income Gap Causes Poor Workers to Revolt3. New System Established

- Workers Own Businesses (Through The State)

4. Evolve to Pure Communism – Workers contribute and only take what they need

Socialism Since Marx• Democratic Socialism – Election of Socialists to Political Office• Government Controls Some Areas of Economy

• Authoritarian Socialism – Revolution to Overthrow Capitalism.• Central Government Controls Entire Economy

Benefits of Capitalism• Personal Freedom and Initiative • Socialism: Total Government Interference

• Marketplace Efficient – Allows for Growth• Socialism: Growth Stagnant

Planned Economies• ALL ECONOMIES ARE PLANNED• Difference is who is doing the planning:• Socialism: Government Does the Planning• Capitalism: Individuals, Businesses, Elected Officials do the

planning• Problems with Capitalism:• Income Inequality• Lacks enough Public Assistance (socialism offers)