ECONOMIC SYSTEMSCh. 2 & 3

TRADITIONALCOMMAND

MARKET

The Three Basic Questions:

Doesn’t matter what type of economic system a country has, all ask the same 3 basic questions of economics:

1. WHAT TO PRODUCE?

2. HOW TO PRODUCE IT?

3. FOR WHOM TO PRODUCE?

TRADITIONAL

Allocation of scarce resources by ritual, custom, or habit, e.g. hunter-gatherer societies

An economy in which the basic economic questions are answered by custom & tradition

Individuals not free to make decisions based on what they want

Economic decisions are based on how they were made in the past

Economy is self-sufficient and mostly make things necessary to survival

TRADITIONAL

No specialization or division of labor

No real changes in technology Producers are their own consumers Bartering, instead of money Examples: the Amish, Indian

cultures in Central & S America

TRADITIONAL

Strengths:• Everyone has defined

role• Little uncertainty over

how, what, for whom Weaknesses:

• Discourages innovation• Discourages satisfaction

of personal wants; tends to have lower standard of living

COMMAND

Economy controlled by the government Government owns all factors of

production (resources, factories, railroads, etc.)

Economic decisions are made by the central government – at the top & people expected to follow

State can shift resources at will to focus on new priorities

a/k/a CENTRAL PLANNING; characteristic of communist countries

Interdependent: much specialization and division of labor

COMMAND

Examples: former Soviet Union, Cuba, Iraq, early People’s Republic of China

Strengths:• Planning agencies can shift resources

quickly on a massive scale – WHY can this type of economy change direction so quickly?

• No unemployment - labor shortages solved by forcing redirection of workers

COMMAND

Weaknesses:• Does not meet needs and wants of individuals• Few consumer goods and very long waits• Little incentive to work – low pay

• (“We pretend to work & they pretend to pay us)”

• People keep jobs for life – so no incentive to work hard

• Large decision-making bureaucracy – out of touch and slow

• Does not move quickly to solve day to day problems

MARKETECONOMY

Privately-owned capital goods are used to produce all goods and services without significant government intervention

People and companies act in own self interest to answer “What, How, For Whom”• Economics decisions are based on supply & demand• Markets allow buyers & sellers to come together

Entrepreneurs! Interdependent: much specialization and

division of labor Highest standard of living Operate based on Adam Smith’s theories

Adam Smith, Wealth of Nations,

1776

In order to have wealth, need to accumulate products that are tangible, scarce, useful, and transferable

Father of Classical Economics Labor is more productive as workers get more skilled Division of labor/specialization leads to increase in

production and thus greater “wealth of nations” Wealth of a nation should be defined as sum of its labor-

produced goods, not who owns them (& not land) Laissez-Faire – minimal governmental intervention Invisible Hand – competition acts as an “invisible hand”

that guides resources to their most productive uses.• All people pursue selfish interests…this benefits whole

society

Adam Smith’s Invisible Hand

Productivity and Wealth

The Circular Flow

Keep TheGovernmentOut Of Our Business!

Laissez-FaireDivision of LaborAnd Specialization

MARKET

Highest production and sale of consumer goods Examples: U.S., Canada, Japan, Great Britain… a/k/a Capitalism & Free Enterprise Strengths:

• Can adjust to change over time – gradual• Change not prohibited or discouraged• Decision making decentralized- resources directed to where

consumers want them• Huge variety of goods and services• Freedom for everyone involved - people decide their own

“What, How, For Whom” with relatively little government interference

MARKET

Weaknesses:• People may be caught without work as the “For

Whom” question is not always clear.• Young and sick may not get support as they are

unproductive• Markets don’t always function optimally – need

competition, resources free to move around, need good market information

• Public goods not naturally provided – why not?

U.S. ECONOMYMixed

• A Modified Private Enterprise Economy• Capitalism modified by government

intervention and regulation• So… market mixed with command.

• What is the current mix?• What is the role of the consumer in the

U.S. economy?• Consumer Sovereignty – consumers rule!

• What is the role of government?• Protector, provider & consumer, regulator,

promotes national goals

5 CHARACTERISTICS:• Economic Freedom

• Choices for consumers & businesses

• Voluntary exchange• Buyers & sellers freely exchange in market

transactions

• Private property rights• Profit motive

• Entrepreneurs

• Competition• Only because private individuals own the factors

of production – better goods, lower price