Economic Systems Chapter 2

Types of Economic Systems

•Economic system:▫how society uses resources to satisfy

people’s wants

•Three basic systems: ▫Traditional▫Command▫market economies

Types of Economic Systems•Traditional

Economy▫centers on families,

clans, or tribes decisions are

based on customs and beliefs

▫Good of the group always comes before individual desires

Characteristics of Traditional Economies

•Advantages and Disadvantages▫Advantages: little disagreement over goals,

roles methods of production, distribution

determined by custom▫Disadvantages: as result of resistance to

change, less productive do not use new methods; people not in jobs

they are best suited for low productivity results in low standard of

living

Types of Economic Systems cont.

• Command Economy▫ (centrally planned

economy) government makes economic decisions determines what to

produce; how to produce; who gets products

determines who is employed, work hours, pay scales

▫ Wants of individual consumers rarely considered

▫ Government owns means of production: resources and factories

Government Controls•EXAMPLE: Socialism and Communism

▫Karl Marx influenced some societies to adopt command economies socialism—government owns some of the

factors of production communism—no private property; little

political freedom▫ Authoritarian system requires total

obedience to government communism is authoritarian socialism

Karl Marx: Economic Revolutionary•A New View of Economics

▫Marx lived during Industrial Revolution▫Argued factory owners used workers as

resource exploited workers by keeping wages low to

increase profits workers would rebel, establish classless

society▫Wrote The Communist Manifesto (with

Friedrich Engels), Das Kapital

Government Controls• Socialism and

Communism▫ Democratic socialism

established under democratic political process government owns basic

industries other industries private central planners make

decisions for government-owned industries

central planners might control other sectors, such as health care

Command Economies TodayNo pure command

economies today modern

telecommunications bringing about change

▫Some economies still have mostly command elements

Command Economies Today• North Korea

▫ Communist North Korea used resources for military, not necessities built large army; nuclear

weapons program In 1990s and early 2000s,

millions died of hunger, malnutrition

In 1990s, production decreased and economy shrank

Since 2003, some market activity allowed

Command Economies Today•Impact of Command Economies

▫In theory, command systems fair to everyone; In practice, many disadvantages central planners do not understand local

conditions workers have little motivation to be

productive or conserve resources artificially low prices lead to shortages people sacrificed to carry out centrally

planned policies

Types of Economic Systems cont.

• Market Economy▫ driven by choices of

consumers and producers consumers spend money,

go into business, sell their labor as they wish

producers decide how to use their resources to make the most money

▫ Consumers, producers benefit each other when they act in self-interest

Fundamentals of a Market Economy•1: Private Property and Markets•2:Limited Government Involvement

▫ Laissez faire—government should not interfere in economy

▫ Capitalism—system having private ownership of factors of production says producers will create products

consumers demand▫Actual market economies all have some

government involvement

Fundamentals of a Market Economy•3: Voluntary Exchange in Markets

▫ Voluntary exchange—traders believe they get more than they give up

•4: Competition and Consumer Sovereignty▫Consumer sovereignty—buyers choose

products, control what is produced▫Competition controls self-interested

behavior sellers offer low price or high value to please

consumers, make profit

Fundamentals of a Market Economy•5: Specialization and Markets

▫ Specialization—people concentrate their efforts in the activities they do best encourages efficient use of resources

leads to higher-quality, lower-priced products

Circular Flow in Market Economies•KEY CONCEPTS

▫ Circular flow model illustrates how interactions occur in a market

▫Represents the two key decision makers: households, businesses

▫Shows the two markets where households and businesses meet goods and services resources

Circular Flow in Market Economies•Factor Markets

▫ Factor market—market for the factors of production land, labor, capital, entrepreneurship

•Product Markets▫ Product market—market where goods and

services bought and sold includes all purchases by individuals from

businesses

Circular Flow in Market Economies•Circular Flow

▫Circular flow model shows how market economies operate outside arrow shows flow of money

inside arrow shows flow of resources and products

Impact of Market Economies

•Advantages▫Individuals free to make economic choices,

pursue own work interests▫Less government control means political

freedom▫Locally made decisions mean better use of

resources, productivity▫Profit motive ensures resources used

efficiently, rewards hard work resulting competition leads to higher-quality,

more diverse products

Impact of Market Economies

•Disadvantages▫Pure market economy has no way to

provide public goods and services▫Does not give security to sick or aged▫During U.S. industrial boom, business

owners rich, workers low pay▫Businesses did not address problems

caused by industrialization▫Industrialized societies adopt some

government control of economy

Today’s Mixed Economies•Mixed economy

▫has elements of traditional, command, market systems most common type of economic system

▫Traditional, command, market economies adopt elements from others

Today’s Mixed Economies• Life in a Mixed Economy

▫ Family farming in U.S. serves as example of mixed economy traditional: all members

of family help bring in harvest

command: affected by government—public school, roads, Social Security

market: own land, sell their products in competitive market

Today’s Mixed Economies•Types of Mixed Economies

▫U.S. basically has market system▫European countries greater mix of market

and command elements France—government controls some

industries; provides social services Sweden—state owns part of all companies;

lifelong benefits, high taxes Namibia—traditional; state supports market,

foreign investment

Trends in Modern Economies•Changes in

Ownership▫Nationalize is to

change from private to government ownership

▫Privatize is to change from government to private ownership