1.3 Economic Systems

Three Economic Questions

1. What goods & services should be produced?

2. How should these goods and services be produced?

3. Who consumes these goods and services?

Economic System

An ________ is the method used by a society to produce and distribute goods and services

Command Economy (aka Communism)

An economic system where a central government makes all major decisions about production, distribution, and pricing of goods and services

Command Economies

In a centrally planned economy (communism) the government….

• Owns all the resources

• Answers all three economic questions

Why do centrally planned economies face problems?

• Centrally planned economies (communist nations) typically face problems of:

  • Poor-quality goods,

  • shortages,

  • and unhappy citizens

• because there is little incentive to work hard

• central planners have a hard time predicting preferences

Advantages of a Command Economy

• Low employment

  • Everyone has a job

• Job security

  • The government doesn’t go out of business

• Equal incomes

  • No extremely poor people

• Free healthcare

Disadvantages of a Command Economy

• No incentives

  • Little to no incentive to work hard

• No new stuff

  • There is no incentive to be innovative or come up with good ideas

• No competition

  • Quality of goods becomes poor due to this

• Corrupt leaders

• Few individual freedoms

Market Economy (aka Capitalism)

Economic system where decisions on production, investment, and distribution are driven by supply and demand in free markets, with minimal government intervention

Adam Smith

• Father of Capitalism

• Wrote the Wealth of Nations (1776)

  • Laid out ideas for capitalism

Characteristics of a Market Economy

• Little to no government involvement

  • Laissez-faire - hands-off government intervention in the economy

• Individuals ownership

  • Individuals own resources and answer the three economic questions

• Profit

  • The opportunity to make a profit gives people the incentive to make high-quality goods

• Variety

  • Wide variety of goods available to consumers

• Competition

  • Competition and self-interest work together to allocate scarce resources

The Invisible Hand

This is the concept that society's goals will be met as individuals seek their own self interself-interestest

• Example: Society wants fuel-efficient cars...

  •profit seeking producers will make more

  •competition between firms results in low prices, high quality, and greater efficiency

  •the government doesn't need to get involved since the needs of society are automatically met

Competiton & self-interest act as an invisible hand that regulates the free market

Mixed Economy

A system with free markets but also some government intervention

What kind of countries have seen historicallky seen greater economic growth because they are more productive?

Countries with:

• free markets

• property rights

• and the Rule of Law

Traditional Economy

• Developing countries

• 3 basic economic questions are answered by what has always been done

  • subsistence agriculture