Economic Systems

Economic systems must answer three questions:

Traditions, customs, belief systems, and inheritance determine the answers to the three economic questions.
Prevalent in underdeveloped areas (South America, Africa, Asia).
The World Bank estimates prevalence among 400 million indigenous people.
Operates through bartering and trading with little surplus.
Most produce only enough to keep their families alive.
Surplus may go to a landowner or ruling authority.
Based on subsistence-based agriculture.

The central government or authority determines the answers to the three economic questions.
The central government owns and manages the economic resources.
The government is the final authority on decisions regarding production, utilization, and allocation of revenues.

Socialism:
- Belief that democratic means should distribute evenly throughout society.
- The working class should take over and run things collectively.
- Focuses on the economic system.
Communism:
- Centrally planned economy with economic and political power in the hands of the central government.
- Requires strict obedience (authoritarian).
- The idea that society should not have classes.
- An extreme form of socialism that shapes both the economic and political systems.
- Example: Former Soviet Union (1920s-1991) - Collectives, heavy industry.

Central government and economy under the control of the communist Korean Workers’ Party.
Determined to maintain control.
All natural resources, railroads, aviation, transportation, postal and communicational institutions, major factories, businesses, ports and banks are owned by the state.
Permits limited personal ownership (savings, home appliances, everyday items).
Individuals can dispose of personal belongings, and inheritance is allowed.
No personal ownership is allowed of the factors of production.

Central planners cannot effectively coordinate production, leading to shortages and surpluses.
Valuable resources are not used efficiently.
Innovation and productivity are stifled.

What to produce?
- The competitive market determines what to produce (“the invisible hand”).
- Very limited government involvement (“Laissez-faire”).
- The market will produce goods that can be sold at a profit.
- Consumers vote with dollars.
- Producers must adapt to the changing environment.
How to produce?
- Firms have an incentive to minimize costs due to competition and the desire to make a profit.
- Efficient production methods are employed; resources tend to be allocated efficiently.
- Technology and innovation are instrumental to success.
For whom to produce?
- Those willing and able to pay.

(1723-1790): Offered an explanation of how a market economy works.
Authored The Wealth of Nations.
Called for laissez-faire, meaning "let them do (as they please)."
Insisted that the government leave individuals as free as possible to pursue their own interests.
Businesses could provide goods and services needed without government direction.
Individuals pursuing their own interests make decisions that ultimately benefit the nation.
The “invisible hand” guides a nation’s resources to their most productive use.

Resources are allocated efficiently (productive as well as allocative efficiency).
Freedom of enterprise (own your own business).
Freedom of economic choice (buy what you want, work where you want).
Encourages innovation and new technology.
Variety of goods.
High degree of customer satisfaction.

The benefits of competition can be eroded by monopoly power.
Inequitable distribution of income (land and capital owned by the few).
The young, old, disabled, and poor are not able to pay for goods and services.
Market failure can occur due to a lack of information, and not all costs (pollution) or benefits (public health) are properly accounted for.

Most economies are mixed economies.
Tradition, government, and markets each answer some of the WHAT, HOW, and FOR WHOM questions.
There is often so much overlapping that it’s hard to define the economy.