1.2: Resource Allocation and Economic Systems

Scarcity and economic systems

Every society must answer the three economic questions

1. What goods and services should be produced?
2. How should these goods and services be produced?
3. Who consumes these goods and services?

• Economic system: the method used by a society to produce and distribute goods and services

Economic systems

• Command (centrally-planned) economy
• Free market economy
• Mixed economy

Centrally-planned economic system (communism)

• Centrally-planned economics: an economic system in which the government owns all the resources and answers all three economic questions
  • Eg. cuba, north korea, USSR, china (?)
• Why to centrally-planned economies face problems of poor-quality goods, shortages, and unhappy citizens?
  • There is little incentive to work harder and central planners have a hard time predicting preferences

Advantages

1. Low unemployment — everyone has a job
2. Great job security — the government doesn’t go out of business
3. Less income inequality
4. “Free” healthcare

Free-market system (capitalism)

Characteristics of a free market

• Little government involvement in the economy (laissez-faire)
• Individuals own resources and answer the three economic questions
• The opportunity to make profit gives people incentive to produce quality items efficiently
• There are a wide variety of goods available to consumers
• Competition and self-interest work together to regulate the economy (keep prices down & quality up)

Concepts

• The invisible hand: the concept that society’s goals will be met as individuals seek their own self-interest

• Competition and self-interest act as an individual hand that regulates the free market

Mixed economic system

• Mixed economics: a system with free markets but also some government intervention
  • Eg. the US and most other modern countries

Models and concepts

The circular flow model

• The product market: the “place” where goods and services produced by businesses are sold to households
• The resource (factor) market: the “place” where resources (land, labor, capital, and entrepreneurship) are sold to businesses

Circular flow model vocab

• Private sector: the part of the economy that is run by individuals and businesses
• Public sector: the part of the economy that is controlled by the government
• Factor payment: a payment for the factors of production
  • Eg. rent, wages, interest, and profit
• Transfer payment: when the government redistributes income
  • Eg. welfare, social security

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