Economic Systems

Compare and contrast strategies for allocating scarce resources.
Compare and contrast different economic systems.
Identify the three basic economic questions.
Define profit motive, competition, government regulation, and the invisible hand.
Analyze how each type of system meets broad social and economic goals.

Every society must answer three questions:
- What goods and services should be produced?
- How should these goods and services be produced?
- Who consumes these goods and services?
The way these questions are answered determines the economic system.
An economic system is the method used by a society to produce and distribute goods and services.

In a centrally planned economy (communism) the government:
- Owns all the resources
- Answers the three economic questions
Examples: Cuba, North Korea, former Soviet Union, and China?
Centrally planned economies face problems of poor-quality goods, shortages, and unhappy citizens because:
- There is little incentive to work harder.
- Central planners have a hard time predicting preferences.

Little government involvement in the economy. (Laissez Faire = Let it be)
Individuals OWN resources and answer the three economic questions.
The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently.
Wide variety of goods available to consumers.
Competition and self-interest work together to regulate the economy (keep prices down and quality up).

If consumers want smartphones and only one company is making them:
- Other businesses have the INCENTIVE to start making smartphones to earn PROFIT.
- This leads to more COMPETITION.
- Which means lower prices, better quality, and more product variety.
- We produce the goods and services that society wants because “resources follow profits”.
The End Result: Most efficient production of the goods that consumers want, produced at the lowest prices and the highest quality.

Other businesses CANNOT start making computers.
There is NO COMPETITION.
Which means higher prices, lower quality, and less product variety.
More phones will not be made until the government decides to create a new factory.
The End Result: There is a shortage of goods that consumers want, produced at the highest prices and the lowest quality.

The Farmer sets prices in the morning.
As customers come in, they make purchases that benefit themselves.
If apples are priced too high, they don’t sell.
After a few hours of poor apple sales, the farmer may choose to lower the price.
Apples sell. The customers are happy. The farmer is happy.
Producers and consumers act in their own self-interest and make adjustments automatically.

The concept that society’s goals will be met as individuals seek their own self-interest.
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.
Competition and self-interest act as an invisible hand that regulates the free market.

A system with free markets but also some government intervention.
Almost all countries, including the US, have a mixed economy.
In a mixed economy:
- individuals own the resources
- the government regulates the production and distribution of many goods/service
- individuals and the government answers the three economic questions
Mixed economies utilize the advantages of free markets (innovation and efficiency) and the advantages of government involvement (public goods and services)

The Heritage Foundation's Index of Economic Freedom measures the performance of 186 countries in 10 areas of economic freedom on a scale of 1 to 100.
Areas of Economic Freedom:
- Property rights
- Freedom from corruption
- Government spending
- Fiscal freedom
- Investment freedom
- Business freedom
- Monetary freedom
- Labor freedom
- Trade freedom
- Financial freedom