Chapter 2 AP Micro

economic systems

• a particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem

differences of economic systems

• who owns the factors of production (resources)

• the method used to coordinate, motivate, and direct economic actively

Laissez-Faire Caplitalism

• very limited government involvement

  • limited to: protecting private property and establishing a legal government (enforce contracts, market interactions)

• proponents argue

  • government will be corrupter by special interest if it is involved in the economy: benefits special interests

  • government should only prevent people and firms from coercing one another; protection only; leads to mutually beneficial transactions

  • never been tried: every government has been more involved

Command System (Communism or Socialism)

• government owns most resources

• central economic plan set and enforced by the government

  • production goals, resource distribution, consumer vs. capital balance

• not as prevalent anymore

market system (capitalism or mixed economy)

• private sector: private ownership of resources, uses markets, businesses make individual decisions for their own benefit, participants act in their own self-interest, profit motivates innovation

• government: economic initiatives (unemployment/inflation), rules for economic activity, provides goods and services, modifies income

private property

• characteristic of the market system

• private (non-governmental) ownership of resources

  • can do what they want with them

  • encourages cooperation (mutually agreeable transaction), investment, innovation, exchange, maintenance of property, economic growth

• intellectual property (patents and copyrights)

freedom of enterprise and change

• characteristic of the market system

• enterprise: private sector can obtain and use resources to produce what they want and sell products as they want

• choice: entities can use or dispose of resources and money as they want

  • can by anything you’re qualified to be

  • can spend on what you want

self-interest

• characteristic of the market system

• each country pursues its own goal

  • maximize profit

  • directs economy

competition

• characteristic of the market system

• 2+ entities pursuing the same goal or resource

  • diffuses economic power: limits abuse of power

  • free to enter or leave market

markets and prices

• characteristic of the market system

• any mechanism that brings buyers and sells together

  • prices are determined by a combination of firms and consumers: dollar voting

technology and capital goods

• characteristic of the market system

• new innovations produce profit for the innovator

  • inspires new technology and capital: keep what you make

specialization

• characteristic of the market system

• use of resources to make a particular or a few things

• exchange them for other goods/services

• division of labor

  • uses different abilities: promotes efficiency

  • fosters learning by doing: develops skill and technique

  • saves time: no shifting from one task to another

• geographic specialization: use particular land resources efficiently

use of money

• characteristic of the market system

• medium of exchange: buys what’s needed/wanted and simplifies trade: no bartering

• can be anything agreed upon

active, but limited, government

• characteristic of the market system

• government is active but within prescribed limits

five fundamental questions

• what will be produced?

  • whatever makes a profit: consumers ultimately decide →dollar voting, directs resources to successful products/industries

• how will the goods and services by produced?

  • combination of resources that produces a lowest cost per unit: maximizes profit, promotes efficiency

• who will get the output?

  • whoever is willing and able to pay: dependent on income and prices

• how will the system accommodate change?

  • self-interest will direct firms towards profit: moves resource allocation, ultimately consumers decide

• how will the systems promote progress?

  • desires: more output, higher standard of living

  • technological advance: creative destruction- new methods will wipe out companies that don’t change

  • capital accumulation: companies dollar vote for resources, including capital

dollar voting

• consumers have full power to choose

• consumer purchasing decisions act as "votes," determining which products and firms succeed or fail in a market economy

• by buying specific goods, consumers signal demand, prompting firms to produce more of what is favored, thus dictating resource allocation and shaping corporate behavior

Adam Smith’s “The Wealth of Nations”

• the individual self-interest of firms and resource provides will promote public welfare: new products, technologies, techniques

• competition makes businesses responsive to consumers

  • efficiency: meets the wants of society, new was equals more profit

  • incentives: profit as a motivator

  • freedom: can do what you want

Demise of the Command Systems

• why didn't they work

  • coordination problem: tried to make decisions for entities, too much or too little produced, failure to meet targets in one industries effects others, lack of variety

    • quality was success gauge: often at an economic loss, changed by how things were produced (weight vs. number)

  • incentive problem: meeting quota was all that mattered (shortages or surpluses), no reward for success/punishment for “failure”

households

• part of the circular flow model

• one or more people occupying a unit of housing

• buy goods and services

• provide resources

businesses

• part of circular flow model

• buy resources

• provide goods and services

sole proprietorship business

• owned and operated by one person

• +: decision making control

• -: limited funding; unlimited liability

partnership business

• two or more individuals own and operate business

• +: increased funding; some specialization

• -: still limited funding; unlimited liability; shared decision making

cooperation business

• legal entity that can acquire resources, own assets, produce and sell products, incure debts, extend credit, sue and be sued

• +: limited liability; funding

• -: principle-agent problem

produce market

• part of circular flow model

• mechanisms selling goods and services

resource market

• part of circular flow model

• mechanisms selling land, labor, capital, and entrepreneurial skill

circular flow diagram

how the market deals with risk

• profit system: the desire for profit and the fear of loss pushes people and firms to manage risk

• shielding employees and suppliers from business risk: contracts with employees and other businesses must be honored (even if you’re operating at a loss)

  • dealing with losses: cannot choose if losses continue, don’t have to share profits

• benefits of restricting businesses risk to owners:

  • attracting inputs- resource providers sell resources without worrying about profits

  • focusing attention- attention is paid to managing risk: avoid losses