Adam Smith’s Market Economy

Economic Logic of a Market System

AP Macroeconomics

Economic Systems Allocate Resources

• Market Command Traditional

Every Economic System has to answer 3 Questions:

1) What to Produce?

2) For whom to Produce?

3) How to Produce it? (or when to produce)

Society will choose an economic system based on goals: Economic & Social

WHAT ECONOMIC SYSTEM?Which Economic System?

• Growth

• Employment

• Efficiency

• Stability

•Justice

•Equality

•Environment

•Freedom

Adam Smith (1723-90)

• Founder of Free Market Economics

• Argued: Free markets best promote the social welfare

• Government should not interfere!

“The Wealth of Nations” Published in 1776

"It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”

“We address ourselves, not to their humanity but of their advantages."

Adam Smith

Self-interest is our incentive to work hard

End Result:

Reading: The Free Market at Work

ScarceResources

HighPrices

Adam Smith & The Invisible Hand

People follow their own self-interest

Threat of competition keeps people honest

Markets naturally self-regulateInvisible Hand

Shortage ofA Good?

Government should notInterfere!

HOW WHAT FOR WHOM

MARKET

COMMAND

TRADITIONAL

Economic System

Production

Growth &

Efficiency

Supply &

Demand

Price

Communism

• Soviet Union “adopts” command economic system

• General Philosophy: – Government controlled economy (centrally planned)

– stressed equality & the common good (collective society)

• Economic Incentive to invent, work hard ?

Karl Marx

1848

Economic Systems Trade-offs

• Efficiency vs. Equity– Free markets focus on efficiency not equity

• Efficiency means society gets the most from its scarce resources

• Equity means the benefits of scarce resources are distributed fairly in society

HOW WHAT FOR WHOM

MARKET

COMMAND

TRADITIONAL

Economic System

Production

Growth &

Efficiency

Supply &

Demand

Price

Equality

Gov’t orCentral PlannerEmployment

Need

[Tradition]

Need/

NecessityStability

Traditional Economic System

Bhutan Video: Traditional Economy

Benefits Costs

Bhutan June 2011

Typical Village

No traffic lights in Bhutan

2011 Music Video production in Bhutan

HOW WHAT FOR WHOM

MARKET

COMMAND

TRADITIONAL

Economic System

Production

Growth &

Efficiency

Supply &

Demand

Price

Equality

Gov’t orCentral PlannerEmployment

Need

[Tradition]

Need/

NecessityStability

Summary

• Market systems stress competition– Work “individually” in your own “self interest”

– Invisible hand regulates economy

• Command systems stress equality– Work “collectively” for the common good

– Government centrally plans economy

• Traditional systems stress preservation of culture– Government maintains culture of society