Economics - Chapter 2: Economic Systems and the American Economy

The Big Idea & Why it Matters

• Every society has an economic system to allocate goods and services.

• As an American, you have many economic choices available. Not all nations offer their citizens the same choices most Americans enjoy.

all economic systems face three basic questions

1. What should be produced?

   1. if more of one particular item is produced, then less of something else will be produced (trade-off)

2. How should it be produced?

   1. decisions must be made as to what the best combination of available inputs will be to get the job done for the lowest possible cost

3. For whom should it be produced?

   1. the type of economic system under which people live determines how the goods and services will be distributed among its members

Traditional Economy

• makes decisions based on customs and beliefs that have been handed down from generation to generation

• advantages: know expectations, strong family and community ties

• disadvantages: change is discouraged and sometimes punished, inefficient methods of production, rare choices among consumer goods, and rare individual experiences of an increased level of material well-being

Command/Controlled Economy

• government leaders control FOP and make all decisions about their use

• advantages: efficiency

• disadvantages: lack of incentive to show inventiveness or work hard, lack of consumer choices

Market/Capitalist Economy

• individuals own FOP and make economic choices based on market price while looking out for their and their families’ best interests

• a model called a circular flow of income and output illustrates how the market system works (dollars flow from businesses to individuals and back to businesses; FOP flow from individuals to businesses, which use them to produce goods and services that flow back to individuals)

• advantages: individual freedoms, wide array of goods and services for consumers to choose from due to competition, efficient system of determining costs

• disadvantages: lack of concern for those too young, old, or sick to work

market

• voluntary exchange of goods and services between buyers and sellers

• prices in a market coordinate the interaction between buyers and sellers

Mixed Economy

• combines characteristics of more than 1 type of economy

• most countries have a mixed economy in which private ownership of property and individual decision-making are combined with gov intervention and regulation

• advantages: most decisions made by individuals reacting as participants within the market, laws made by federal, state, and local governments protect private property and regulate areas of business (reduced inequality), economic stability and efficiency

• disadvantages: higher costs and taxes to fund public services, excessive regulation stifles profit motive (reducing efficiency of private sector)

capitalism

• AKA market economy system

• an economic system in which private individuals own FOP, but use them within certain legislated limits

• under capitalism, gov plays a relatively limited role in the allocation of resources

• pure capitalism AKA “laissez-faire” economics (French for “let (people) do (as they choose)) is a hands-off system

Characteristics of the American System

• the free market allows economic activity to be coordinated by private business and individuals responding to market signals like holidays

• the FES means that individuals are free to own FOP and decide how to use them within legal limits; individuals also have freedom of choice as buyers, not sellers make the decision about what should be produced (gov has intervened in various areas of the economy to protect buyers and regulate pricing)

• the FES also means there is a profit incentive/motive, which is the goal of a business, as well as the risk of failing should the profits not be realized

• the lure of profit encourages competition; for competition to exist, industry barriers to enter into and exit off from must be weak; competition leads to an efficient use of resources since businesses are forced to keep costs of production as low as possible

• 1 of the most important characteristics in capitalism is the existence of private property

Rights and Responsibilities

• individuals have both rights and responsibilities in FES

• American FES bestows numerous economic rights and protections on us, but we must take on certain responsibilities

• we must be knowledgeable about gov policy and elect responsible gov officials

pure socialism

• an economic system in which there is little private property and the gov owns FOP and attempts to manage output and the distribution of goods

• characterized by centralized economic planning and state ownership of FOP

• no countries (Cuba might be considered)

Karl Marx

• viewed history as a continual struggle between capitalists (owners of land, machines, and factories) and proletariat (workers)

• believed that capitalists exploited the proletariat

• outlined the eventual collapse of capitalism

• predicted the evolution of socialism into communism (an idealized society in which no gov is necessary)

communism

• an authoritarian socialist system that supports revolution as a means to overthrow capitalism and bring about socialist goals

• in the 20th century, socialism split into 2 major trends: democratic and authoritarian

• North Korea, China, Vietnam, Laos, Cuba

democratic socialism

• a type of socialist system that works within the constitutional framework of a nation to elect socialists to office

• gov usually controls some areas of the economy

authoritarian socialism

• more closely follows Marx’s beliefs

• advocates revolution as the means to overthrow capitalism and bring about socialist goals

• a central gov control the entire economy

• any authoritarian socialist system is communism

Benefits of Capitalism

• economic efficiency and individual freedom

• supporters of capitalism value freedom, initiative, and individuality; demonstrate that capitalism allows more efficiency in the market place and greater rates of economic growth

All Economies Are Planned

• U.S. has an economy planned by private firms, individuals, and elected gov officials

• socialism has an economy planned by central planners

Problems of Capitalism

• income is unequally distributed throughout the economy

• not enough schools and museums for general public

2 Concepts Economists Have Always Struggled With

1. origin of market values

2. reason why economic trade and production proceed in orderly fashion without supervision

Greece: Equality in Exchange Idea

Socrates:

• teaching, reason, and logic guide life; question all beliefs; evil results from ignorance

Plato:

• wrote The Republic; division of labor (work that suits ability best is the ideal/assigned role); state’s role is to protect

Aristotle:

• Plato’s student; criticized “ideal state;” didn’t question slavery; people pay more attention to private property and less to that which they have but a part interest

Greece and Rome: Scholasticism

Thomas Aquinas:

• wrote Summa Theologica (faith and reason); “Just Price Theory” (if a price exceeds the value of a thing or if the value exceeds the price, justice is violated)

17th Century: Mercantilism

• world contains a fixed amount of wealth measured by gold and silver

• goal is to take wealth from other countries; more money means more power

• export goods and import precious metals

• high tariffs are good and make foreign goods more expensive to emphasize domestic goods

• balance of trade: tariffs, manufactured goods (not raw), self-sufficiency (colonies)

  • colonizing country (Britain) made manufactured goods by using raw materials from the colony (U.S.), which they sold the manufactured goods to

Jean Baptiste Colbert:

• advisor to Louis XIV of France

• brought in mercantilism and improved manufacturing; France became leading European country in industry and trade

17th-18th Centuries: Physiocracy

natural law:

• limited government

• protection of private property

• gov aid to agriculture, otherwise let economic activities develop naturally

18th Century: Modern Economics/Classical School

Adam Smith

• teacher at University of Glasglow

• gov should not regulate business; economy led and regulated by “invisible hand” (supply, demand, and competition)

• promoted free enterprise and “laissez-faire”

• Subjective Value Theory: we place our own value on things due to our individual ideas and values

Thomas Malthus:

• English minister and economics proffesor

• pessimism of “population explosion;” world population growing faster than food production, people will always struggle to survive»no ideal society

• economics is the “dismal science”

David Ricardo:

• London stockbroker, served in House of Commons

• “Comparative Advantage Theory” for international trade (more efficient to pay maid to clean that surgeon) as foreign trade benefits the world; need to concentrate on producing goods for which they are suited

• “iron law of wages” since if population increases»workers increase»wages decrease; human misery and poverty are inevitable

• economics is the “dismal science”

John Stuart Mill:

• supported union, liberal, and women’s movement

• worked to correct problems due to industrialization

• gov should protect workers and working children and improving housing and factory conditions

Industrial Revolution: Value in Use

Jeremy Bentham:

• English philosopher, supported union and improved conditions

• capitalism (keep industry in private hands, gov only step in to correct abuses)

• utilitarianism: every act of society should be judged in terms of its utility or usefulness (“greatest good for greatest number of people)

19th Century: Labor Theory

Karl Marx:

• wrote the Communist Manifesto; was a socialist

• labor is sold source of value; stealing if charge greater than value of labor

• value of goods depends on how much labor is used to produce

• history decided by how people make a living, by economics; working people have little to no political power

• failed to recognize subjective values in price

• workers have slim chance of excelling because of “iron law of wages”»class struggle between rich and poor

• capitalism is an alien monster that would destroy society

• need to abolish profit incentive and competition

Marx Theory

human history moved through several stages, each involving inequality and struggle

1. Tribes (shared property/work)

2. Slavery (slave owners and slaves that are owned property and forced to work)

3. Feudalism (landowners and serfs that depended on landowners for land and food)

4. Capitalism (capitalists and proletariat; capitalists owned machinery and tools and employed workers)

5. Communism (classless society)

• all wealth created by labor

• under capitalism, wealth goes to owners for profit

• workers revolt, seize power, and establish “socialism”

• become experienced working together cooperatively

• state withers away until the “classless society” becomes pure communism

20th Century: Keynesian Economics

John Maynard Keynes:

• British economist

• developed fiscal policy during Great Depression

• supported liberal use of gov spending and taxing to help economy

• in serious recession, forces of supply and demand operate too slowly, and gov should step in to stimulate aggregate demand

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