Unit 1 Notes - Basic Problems in Economics

Three Basic Questions (p. 34-35)

1. Introduction

      1. The way a nation determines how to use its resources to satisfy people’s needs and wants is called an economic system
      2. Nations have different economic systems, but each is faced with answering the same three basic questions: what goods and services should be produced, how should they be produced, and who should share in what is produced?
   2. What Should be Produced?

1. If more of one particular item is produced, then less of something else will be produced because we live in a world of scarcity and trade-offs

         1. If the government divides to build new roads, fewer resources are available to maintain national parks; if the city decides to hire more police officers, fewer funds are available to add teachers to classrooms; an automobile manufacturer must decide whether to produce pickup trucks, minivans, sport utility vehicles, or luxury cars and how much of each
   3. How Should It Be Produced?

1. After deciding what to produce, an economic system must then decide how those goods and services will be produced

         1. Questions such as how many laborers will be hired, whether will they be skilled or unskilled, will capital goods be used to manufacture the products, thus reducing the number of laborers needed, and what kinds of technology will be used in the production process are asked
      2. For each good and service produced, there are always trade-offs possible among the available factors of production. 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
   4. For Whom Should It Be Produced?

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

         1. In the United States and many other countries, most goods and services are distributed to individuals and businesses through a price system.
         2. Other economic systems may distribute products through majority rule, through a lottery, on a first-come-first-served basis, by sharing equally, by military force, and in a variety of other ways

Types of Economic Systems (p. 36-40)

1. Introduction

1. Economists have identified four major types of economic systems

1. The four general types of economic systems are traditional, command (or controlled), market (or capitalist), and mixed

            1. The systems described are theoretical representations of economies found throughout the world. No “pure” systems truly exist - they are all mixed to some degree
   2. Traditional System

      1. Answers the three basic questions according to tradition. Economic decisions are based on customs and beliefs – often religious – handed down from generation to generation
      2. Advantages of living in a traditional economy are that you know what is expected of you and that family and community ties are usually very strong
      3. Disadvantages include an economy in which change is discouraged and perhaps even punished, and the methods of production are often inefficient. Choices among consumer goods are rare, and people living and working in traditional economies rarely experience an increasing level of material well-being
   3. Command System

      1. Somewhat similar to the traditional economy in that the individual has little, if any, influence over how the basic economic questions are answered, but in a command or controlled economy, government leaders, not tradition, control the factors of production and make all of the decisions about their use
      2. Decisions in government may be made by one person, a small group of leaders, or a group of central planners in an agency. These people chose what is to be produced, how resources are to be used at each stage of production, and how goods and services will be distributed
      3. Disadvantages of such a controlled economy include a lack of incentives to work hard or show inventiveness – because the government sets workers’ salaries there is no reason to work efficiently – as well as a lack of consumer choices
   4. Market System

1. In a market economy, economic systems aren’t made by the government, but by individuals looking out for their own and their families' best interests.

1. Individuals decide for themselves the answer to the three basic questions. Individuals own the factors of production and therefore choose what to produce and how to produce it. Individuals also chose what to buy with the income received from selling their labor and other resources.

            1. These choices are guided by information in the form of market prices
      2. A market is the voluntary exchange of goods and services between buyers and sellers. This exchange may take place on a large scale, such as the world market, or a small scale, such as a neighborhood market.

         1. Prices in a market coordinate the interaction between buyers and sellers. As prices change, they act as signals to everyone within the system as to what should be bought and what should be produced
         2. The flow of resources, goods, services, and income in a market system is actually circular. Economists use a model called a circular flow of income and output to illustrate how the market system works - money moves from individuals to businesses and back to individuals, and the factors of production flow from individuals to businesses, which use them to produce goods and services that then flow back to the individuals
      3. Advantages of a pure market system include the freedoms to choose a career, to spend their income how they wish, to own property, and to take risks and earn profits. The existence of competition provides consumers with a wide array of goods and services, as well as an efficient system of determining costs
      4. A disadvantage of a pure market system is concerns over those too young, too old, or too sick to work
   5. Mixed System

1. Combines the basic elements of a pure market economy and a command economy.

         1. Most countries of the world have a mixed economy in which private ownership of property and individual decision-making are combined with government intervention and regulation
         2. Most decisions are made by individuals reacting as participants within the market, but federal, state, and local governments make laws protecting private property and regulating certain areas of business, such as certain environmental protections, safety guidelines for workers, and laws to protect consumers

Limited Role of Government (p. 43)

1. Introduction

1. In 1776, economist Adam Smith said that individuals left on their own would work for their own self-interest and in doing so would be guided as if by an “invisible hand” to use resources efficiently and thus achieve the maximum good for society

         1. This version of an ideal economic system is called capitalism, another name for the market system. Pure capitalism is also called a laissez-faire system
      2. The role of the government in the United States was mainly limited to national defense and keeping the peace. Since the 1880s, the role of the government (federal, state, and local) has significantly increased. Among other things, federal agencies regulate the quality of various foods, drugs, watch over the nation’s money and banking system, inspect the workplace for hazardous conditions, and guard against damage to the environment. The federal government also uses tax revenues to provide programs such as Social Security and Medicare and local governments have expanded their roles in areas such as education, job training, recreation, and care for the elderly

         1. Capitalism as practiced in the United States today would best be defined as an economic system in which private individuals own the factors of production but use them within certain legislated limits
      3. Freedom of Enterprise - Individuals are free to own and control the factors of production
      4. Freedom of Choice - Buyers, not sellers, make decisions on what should be produced
      5. Profit - The amount left after all costs of production have been paid, including wages, rents, interest, and taxes.

         1. The desire to make a profit is called the profit incentive, or profit motive. The profit incentive motivates entrepreneurs to produce new goods and services
      6. Competition - Rivalry among producers of similar products or services to win more business by offering lower prices or better quality.

         1. Effective competition often requires a large number of independent sellers, which means that no single company can noticeably affect the price of a particular product or service. If one company raises its prices, potential customers can go to other sellers
      7. Private Property - Property that is owned by individuals or groups rather than by the federal, state, or local government

1. Rights of property are actually the rights of humans to risk investment, own productive assets, learn new ways of producing, and then to enjoy the benefits if these choices result in profits

Goals of Free Enterprise (p. 48-49)

1. Introduction

      1. The United States has a free-enterprise, or capitalist, system. Among the national goals of Americans are freedom, efficiency, equity, security, stability, and growth.
      2. The goal of economic freedom is to allow each member of society to make choices. Americans have one of the highest degrees of freedom in the world to start their own businesses, to own private property, and to pursue other economic choices
      3. Using our limited resources wisely is the goal of economic efficiency. Because of scarcity, if any of the factors of production are wasted, fewer goods and services will be produced overall
      4. Americans want their economic system to be fair and just, which is the goal of economic equity

         1. We encourage our policymakers to pass laws such as those dealing with equal pay for equal work, fairness in hiring practices, and help for disabled workers
      5. Another goal is economic security - protection against risks beyond our control, such as accidents on the job, natural disasters, business and bank failures, and poverty in old age.

         1. This security is provided in a number of government programs
      6. The goal of economic stability is to reduce extreme ups and downs in the standard of living - the material well-being of an individual, group, or nation. The standard of living is measured by the average value of goods and services used by the average citizen during a given period of time
      7. Economic growth means producing increasing amounts of goods and services over the long term. As the population increases, the economy must also expand in order to provide for additional wants and needs.
      8. Rights and Responsibilities - A free enterprise system will not work if individuals don’t take on certain responsibilities

1. The first is to be able to support yourself and your family

            1. You have a responsibility to use your education in a way that helps you to become a productive member of the free enterprise system
         2. Individuals in our system have the responsibility to elect responsible government officials

1. This requires both the knowledge of government policies and the ability to analyze the consequences of those policies