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Economic Systems
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Chapter 2: Economic Systems
KEY CONCEPT• An economic system is the way in which a society uses its resources
to satisfy its people’s unlimited wants.
WHY THE CONCEPT MATTERS• An economic system determines what to produce, how to produce,
and for whom to produce. Countries have mixed systems, but some systems give more economic and political freedom and create more wealth than others.
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Types of Economic SystemsKEY CONCEPTS
• Economic system—how society uses resources to satisfy people’s wants
• Three basic systems: traditional, command, and market economies• Mixed economies have features of more than one type of system
Introduction to Economic Systems
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Types of Economic Systems
TYPE 1: Traditional Economy• Traditional economy centers on families, clans, or tribes
– decisions are based on customs and beliefs• Everyone has a set role; no chance of deviating from pattern• Good of the group always comes before individual desires
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Types of Economic Systems
TYPE 2: Command Economy• Command economy—government makes economic decisions
– determines what to produce; how to produce; who gets products• Wants of individual consumers rarely considered• Government owns means of production: resources and factories
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Types of Economic Systems
TYPE 3: Market Economy• Market economy driven by choices of consumers and producers
– consumers spend money, go into business, sell their labor as they wish
– producers decide how to use their resources to make the most money
• Consumers, producers benefit each other when they act in self-interest
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Characteristics of Traditional Economies
KEY CONCEPTS• Early societies all had traditional economies• Traditional systems help societies survive• Tend to be inefficient; do not adapt to change
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Characteristics of Traditional Economies
TRAIT 1: Advantages and Disadvantages• Advantages: little disagreement over goals, roles
– methods of production, distribution determined by custom• Disadvantages: as result of resistance to change, less productive
– do not use new methods; people not in jobs they are best suited for
– low productivity results in low standard of living
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Characteristics of Traditional Economies
TRAIT 2: Under Pressure to Change• Many traditional economies under pressure to change• Kavango people of Namibia lived as subsistence farmers for
centuries• Modern telecommunications brought Kavango images of outside
world– thousands have moved to cities– a few have turned to commercial farming
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Reviewing Key Concepts
Use each of the terms in a sentence:• traditional economy• command economy• market economy
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Government ControlsKEY CONCEPTS
• Centrally planned economy—central government makes all decisions
• Decides for whom to produce in part by setting wages– only some people have money to buy available products
Command Economies
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Government Controls
EXAMPLE: Government Planning• In all societies, government exerts some control over people’s lives• In centrally planned economy, government exerts great control
– determines businesses to operate, amount produced each month– determines who is employed, work hours, pay scales
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Government Controls
EXAMPLE: Socialism and Communism• Karl Marx influenced some societies to adopt command economies
– socialism—government owns some of the factors of production– communism—no private property; little political freedom
• Authoritarian system requires total obedience to government– communism is authoritarian socialism
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Government Controls
EXAMPLE: Socialism and Communism• Democratic socialism established under democratic political process
– government owns basic industries– other industries private– central planners make decisions for government-owned industries– central planners might control other sectors, such as health care
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Karl Marx: Economic Revolutionary
A New View of Economics• Marx lived during Industrial Revolution• Argued factory owners used workers as resource
– exploited workers by keeping wages low to increase profits– workers would rebel, establish classless society
• Wrote The Communist Manifesto (with Friedrich Engels), Das Kapital
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Command Economies Today
KEY CONCEPTS• No pure command economies today
– modern telecommunications bringing about change• Some economies still have mostly command elements
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Command Economies Today
North Korea• Communist North Korea used resources for military, not necessities
– built large army; nuclear weapons program– In 1990s and early 2000s, millions died of hunger, malnutrition– In 1990s, production decreased and economy shrank– Since 2003, some market activity allowed
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Command Economies Today
Impact of Command Economies• In theory, command systems fair to everyone; In practice, many
disadvantages– central planners do not understand local conditions– workers have little motivation to be productive or conserve
resources– artificially low prices lead to shortages– people sacrificed to carry out centrally planned policies
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Reviewing Key Concepts
Write a brief paragraph explaining the links between the following three terms:
• centrally planned economy• socialism• communism
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Fundamentals of a Market EconomyKEY CONCEPTS
• Private property rights—right to own businesses and resources• Property means material objects, money, intellectual property, labor• Market—place or situation where people buy and sell goods,
services
Market Economies
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Fundamentals of a Market Economy
FEATURE 1: Private Property and Markets• Private property rights must be defined and protected by law• Buyers must be sure sellers have right to sell products they offer• Sellers must be sure they will be paid for their products
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Fundamentals of a Market Economy
FEATURE 2: Limited Government Involvement• Laissez faire—government should not interfere in economy• Capitalism—system having private ownership of factors of
production– says producers will create products consumers demand
• Actual market economies all have some government involvement
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Fundamentals of a Market Economy
FEATURE 3: Voluntary Exchange in Markets• Voluntary exchange—traders believe they get more than they give
up• In market economy, most trade is exchange of product for money• Profit—financial gain from business transaction
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Fundamentals of a Market Economy
FEATURE 4: Competition and Consumer Sovereignty• Competition—sellers’ efforts to get business by offering best deal• Consumer sovereignty—buyers choose products, control what is
produced• Competition controls self-interested behavior
– sellers offer low price or high value to please consumers, make profit
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Fundamentals of a Market Economy
FEATURE 5: Specialization and Markets• Specialization—people concentrate their efforts in the activities they
do best– encourages efficient use of resources– leads to higher-quality, lower-priced products
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Circular Flow in Market Economies
KEY CONCEPTS• Circular flow model illustrates how interactions occur in a market• Represents the two key decision makers: households, businesses• Shows the two markets where households and businesses meet
– goods and services– resources
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Circular Flow in Market Economies
Product Markets• Product market—market where goods and services bought and sold
– includes all purchases by individuals from businesses
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Circular Flow in Market Economies
Factor Markets• Factor market—market for the factors of production
– land, labor, capital, entrepreneurship• Individuals own all factors of production
– own some outright, such as labor; some indirectly, such as stocks– individuals are producers; businesses are customers
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Circular Flow in Market Economies
Circular Flow• Circular flow model shows how market economies operate
– outside arrow shows flow of money– inside arrow shows flow of resources and products
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Impact of Market Economies
KEY CONCEPTS• Late 1940s to early 1990s, many countries had command systems
– U.S.S.R., Eastern Europe, China, much of SE Asia, Cuba, North Korea
• Most of these countries have now adopted market systems– remaining communist countries using some market measures
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Impact of Market Economies
Advantages• Individuals free to make economic choices, pursue own work
interests• Less government control means political freedom, less bureaucracy• Locally made decisions mean better use of resources, productivity• Profit motive ensures resources used efficiently, rewards hard work
– resulting competition leads to higher-quality, more diverse products
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Impact of Market Economies
Disadvantages• Pure market economy has no way to provide public goods and
services• Does not give security to sick or aged• During U.S. industrial boom, business owners rich, workers low pay• Businesses did not address problems caused by industrialization• Industrialized societies adopt some government control of economy
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Reviewing Key Concepts
Explain the relationship between the terms in each of these pairs:
• private property rights and market• laissez faire and capitalism• specialization and profit• factor market and product market
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Today’s Mixed EconomiesKEY CONCEPTS
• Mixed economy has elements of traditional, command, market systems– most common type of economic system
• Traditional, command, market economies adopt elements from others
Modern Economies in a Global Age
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Today’s Mixed Economies
Life in a Mixed Economy• Family farming in U.S. serves as example of mixed economy
– traditional: all members of family help bring in harvest– command: affected by government—public school, roads, Social
Security– market: own land, sell their products in competitive market
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Today’s Mixed Economies
Types of Mixed Economies• Most economies emphasize one type; U.S. basically has market
system• Many European countries greater mix of market and command
elements– France—government controls some industries; provides social
services– Sweden—state owns part of all companies; lifelong benefits, high
taxes– Namibia—traditional; state supports market, foreign investment
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Trends in Modern Economies
KEY CONCEPTS• Economies change in response to natural, social, political changes• East European economies changed after fall of communism
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Trends in Modern Economies
TREND 1: Changes in Ownership• Economies in transition often go through changes in ownership• To nationalize is to change from private to government ownership• To privatize is to change from government to private ownership
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Trends in Modern Economies
TREND 2: Increasing Global Ties• Growth of global economy—economic actions across national
boundaries– recent agreements open up world markets to trade among
countries– fast, safe, cheap transport of resources, products eases
distribution– phone, computer links make financial transactions quick,
inexpensive– cross-border business partnerships lower research, production
costs
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Reviewing Key Concepts
Write a sentence that illustrates the meaning of each of the following terms:
• mixed economy• Nationalize• Privatize• global economy
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Case Study: Contrasting Economies: North Korea and South KoreaBackground
• Korea was a single country until end of World War II• North Korea has communist government, command economy• South Korea is democracy with market economy
What’s the Issue?• How effective are command and market economies?
Thinking Economically1. Based on documents A and C, in which country does the government
appear to be more involved in controlling business and the economy?2. Based on documents A and C, what can you infer about the effects of
government activities on productivity in the two nations?3. In today’s global economy, is a command economy or a market
economy more likely to succeed? Support your answer with information presented in the three documents.