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Chapter 2

Economic Systems. Chapter 2. Three Key Economic Questions. What goods and services should be produced? How should these goods and services be produced? Who consumes these goods and services?

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Chapter 2

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  1. Economic Systems Chapter 2

  2. Three Key Economic Questions • What goods and services should be produced? • How should these goods and services be produced? • Who consumes these goods and services? • An economic system is the structure of methods and principles a society uses to produce and distribute goods and services

  3. What goods and services should be produced? • Each society must decide what to produce in order to satisfy the needs and wants of its people • Societies ask, How much of our resources should we devote to national defense, education, or consumer goods? • Because resources are scarce, societies must take into account the opportunity cost

  4. How should goods an services be produced? • Although there are many ways to produce goods and services, all require land, labor, and capital • The factors of production can be combined in many different ways (figure 2.1) • The decision will always involve a trade-off

  5. Who consumes goods and services? • This is determined by how societies distribute income (how does our society do this?) • Factor payments are the income people receive in return for supplying factors of production • Landowners collect rent, workers earn wages, and those who lend money receive payments called interest • Profit is the amount of money a business receives in excess of its expenses • Profits reward entrepreneurs for taking the risk of starting a business

  6. Economic Efficiency • Because resources are scarce, societies always try to maximize what they can produce with the resources they have • If societies can accurately assess what its people wants and needs, it increases efficiently • If an economy can not deliver the right goods in the right quantity to the right people at the right price, it is not efficient

  7. Economic Freedom and Equity • Most people value the opportunity to make their own choices • People in some places in the world still face limitations on their economic freedom • Equity and fairness is another economic goal • Society must decide how to divide the economic pie

  8. Economic Safety • Most people do not like uncertainty • Economic systems seek to reassure people that goods and services will be available when needed and that they can count on receiving expected payments on time • A safety net, or set programs to protect people who face unfavorable economic conditions such as layoffs, injuries, or natural disasters • Some base income for retired people

  9. Economic Growth and Goals in Conflict • A nations economy must grow with its population so it can provide jobs for the new people joining the workforce • Standard of living or level of economic prosperity • Innovation is the process of bringing new methods, products, or ideas into use • The industrial revolution brought the standard of living up • Environmental protection, full employment, or protecting national industries may be among a nations chief economic goal • All nations must prioritize the order of importance

  10. Traditional Economies • A traditional economy relies on habit, custom, or ritual to answer the three economic questions • There is little room for innovation or change • Found in communities that stay small and close • They can be economically successful if they meet their own needs

  11. Why Markets Exist • A market is any arrangement that allows buyers and sellers to exchange things • Ex. Stock Market, farm market • Markets eliminate the need for any one person to be self-sufficient • None of us produce all we require to satisfy our needs and wants • Markets allow us to exchange the things we have for the things we want

  12. Specialization • Specialization is the concentration of the productive efforts of individuals and businesses on a limited number of activities • Leads to efficient use of land, labor, and capital • Avoids wasting • Top performers in most fields are called specialists • Also allows businesses to use capital and labor more efficiently

  13. Buying and Selling • We need a mechanism that allows us to sell what we have produced and buy what we want • People earn income from their jobs by specializing in a particular field • They use their income to buy products that they want to consume

  14. Free Market Economy • A free market economy answers the three key economic questions by voluntary exchange in markets • Individuals determine what gets made, how it is made, and how much people consume • Called capitalist economies because the capital that entrepreneurs invest in business is a vital part of the system • Individuals and privately owned business own the factors of production, make what we want, and buy what they want

  15. Households and Firms • A household is a person or group of people living in a single residence • Households own the factors of production • Also are consumers of goods and services • A firm is an organization that uses resources to produce a product or service, which then sells it • Firms transform inputs, or factors of production, into outputs, or goods and service

  16. Factor and Product Markets • Firms purchase factors of production from households called the factor market • They rent land, hire workers, and borrow money from households and pay back interest • The arena in which households buy goods and services that firms produce is the product market • Households purchase the products made by the firms with the money they received from firms in the factor market

  17. Self-Interest • Adam Smith in 1776 published the book Wealth of Nations • Described how markets work • Observed that an economy is made up of countless individual transactions • In these exchanges the buyer and seller consider their own self-interest, or an individuals personal gain • Self-interest is the motivating force in the free market

  18. Competition • Consumers pursuing their own self interest have the incentive to look for lower prices • An incentive is the hope, the reward or fear of penalty that encourages a person to behave a certain way • Based on money or personal satisfaction • Adam Smith observed positive and negative incentives • Competition is the struggle among producers for dollars of consumers

  19. The Invisible Hand • Self-interest and competition work together to regulate the marketplace • Self-interest spurs consumers to purchase certain goods • Competition causes firms to produce more and moderate the desire to raise prices • The invisible hand is the mechanism that Adam Smith described as the self-regulating nature of the marketplace

  20. Advantages of the Free Market • Economic efficiency • Economic freedom • Economic growth • Consumer sovereignty • The consumers have the power to decide what is produced • No country runs under a pure, unregulated free market system

  21. How Central Planning Works • A centrally planned economy, the government, rather than individual producers and consumers, answer the three economic questions • A central bureaucracy decides what items are produced, how to produce them, and who gets them • The gov’t owns the labor and the capital • Decides labor because they control where someone works and what they get paid

  22. How Central Planning Works • Centrally planned economies, aka command economies, operate in direct contrast to free market system • Oppose private property • Oppose free market pricing • Oppose competition • Oppose consumer choice • Self-interest and competition are absent • Refer to the example on page 35-36

  23. Socialism and Communism Socialism Communism The central gov’t controls all resources and means of production and makes all economic decisions From the ideas of Karl Marx who said that capitalism caused the exploitation of workers and an unfair distribution of wealth Communist gov’t are always authoritarian which limits freedoms and requires a strict obedience of its people • Based on the belief that wealth should be distributed evenly • Economic equity can only exist if the centers of economic power are controlled by the gov’t or by the public as a whole instead of individuals • Market socialism in Sweden allows the gov’t to redistribute wealth through taxation

  24. Two Communist Economies U.S.S.R. China Gov’t planners controlled every aspect of the economy It allowed some private farmland while they focused on industry 1950 they forced peasants on farming communes and sent factory workers 1970s they gave more land to farmers and offered bonuses to factory managers fro better quality products • Stalin had a five year plan to boost industrial and agricultural production • They allocated the best land, labor, and capital to the military and heavy industry • Many other industries were left with low quality resources • Good were poorly made and shortages occurred

  25. Disadvantages of a Centrally Planned Economy • Refer to page 38

  26. Reasons for Government Involvement • When left alone the free market would provide the greatest benefits for consumers and raise the standard of living • Laissez faire is the doctrine that government generally should not intervene in the marketplace • Adam Smith believed in a limited degree of gov’t involvement

  27. Reasons for Government Involvement • Some of the needs of modern society would be difficult to meet in the marketplace • Ex. Highway systems and national defense • Governments supply some needs in order to ensure that all members of society benefit • Public schools

  28. Reasons for Government Involvement • Governments also play a role in the economy by protecting property rights • Fifth and Fourteenth Amendment say “no person can be deprived of Life, Liberty, or Property, without due process” • Private property or property owned by individuals or companies and not by the government or the people as a whole

  29. Reasons for Government Involvement • The government tries to make sure that exchanges in the marketplace are fair • Laws require businesses to give honest information to consumers or block firms from joining together to prevent competition and fix prices • Mixed economy is a market based economic system in which the government is involved to some extent (Cir Flow Chart pg. 40)

  30. North Korea and China • Communist country is dominated by the government • The gov’t owns all property and output • State owned industries produce 95% of N. Korea’s goods • Nearly all imports are banned • Goods and services by foreign companies is forbidden • China is moving toward a more mixed economy • Economic transition is a period of change in which a nation moves toward a different economic system • Privatization is the process of selling businesses or services to individual investors

  31. Mixed Economies Where Markets Dominate • Hong Kong and Singapore have the world’s freest market • In Hong Kong, the private sector rules • The gov’t protects private property and rarely interferes • Receptive to foreign investment and no barriers on trade • Banks operate freely and foreign banks get many of the same benefits • United States runs a mixed economy called a free enterprise system • Characterized by individual or corporate ownership of capital goods

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