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The Invisible Hand & Why Command Systems Fail. Mr. Henry AP Economics. Review 5 Fundamental Questions:. What will be produced ? How will the goods and services be produced ? Who will get the output ? How will the system accommodate change ? How will the system promote progress ?

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review 5 fundamental questions
Review 5 Fundamental Questions:
  • What will be produced?
  • How will the goods and services be produced?
  • Who will get the output?
  • How will the system accommodate change?
  • How will the system promote progress?

Equation:

  • Total Profits = Total Cost – Total Revenue
  • Total Cost = Presource * Qresource
  • Total Revenue = Price * Qsold
  • Table 2.1 ($15 worth of soap): If Bar Soap, Inc. sold 50 bars of soap daily at .25C each, would Bar Soap, Inc. continue to stay in business?
the invisible hand
The “Invisible Hand”
  • Adam Smith, in 1776, wrote The Wealth of Nations in which he noted that the operation of a market system creates a curious unity between private interests and social interests.
self interest
Self Interest
  • Self-interest is what induces responses appropriate to the changes in society’s wants. Competition controls or guides self-interest such that self-interest automatically and quite unintentionally furthers the best interest of society.
slide6

The Market System:

  • Promotes the efficient uses of resources by guiding them into the production of goods and services most wanted by society
  • Encourages skill acquisition, hard work, and innovation. These are incentives because working harder leads to higher income which =‘s higher standard of living
  • Allows for the freedom of enterprise and choice.
slide7

As we will see in the spring, economists (Keynes, Friedman, Hayek) and politicians (Supply-Side vs. Demand-Side) alike have their viewpoints on how the market system should work

why command systems fail
Why Command Systems Fail?
  • Command systems face two major problems:
  • Coordination Problems
  • Incentive Problems
slide9

Central planners have to coordinate millions of individual decisions by consumers, resource suppliers, and businesses.

  • Because new products & inventions arise, planners would suppress product variety and focus on only 1 or 2 products.
  • Managers and workers worried about quantity, not quality, targets. So distortions of what was made occurred.
  • Example: Nails (tons of nails vs. # of nails) = (large nails produced vs. small nails produced)
slide10

Because central planners determined the output, when they misjudged how many items to produce, there were persistent shortages and surpluses of goods.

  • Managers had no incentive to adjust production levels in response to shortages and surpluses.
  • There was no incentive to do better. A higher standard of living meant moving up the political hierarchy, not working harder.
slide12

The price of a new car

  • With the Market Economy, the economy flows in a continuous, repetitive flow of goods & services, resources, and money.

Labor, land, capital, entrepreneurial ability

review questions
Review Questions

1) Suppose industry A is realizing substantial economic profit. Which of the following best describes what will happen in this competitive market?

A Firms will leave the industry and output will fall.

B Firms will enter the industry and output will fall.

C Firms will leave the industry and output will rise.

D Firms will enter the industry and output will rise.

D Firms will enter the industry and output will rise.

slide14

2) According to the concept of the "invisible hand," if Susie opens and operates a profitable childcare center, then:

A government should regulate the business to ensure quality.

B the profit Susie earns indicates that she is overcharging for her services.

C she has served society's interests by providing a desired good or service.

D this demonstrates that consumer sovereignty is not present in this market.

C she has served society's interests by providing a desired good or service.

slide15

3) In terms of the circular flow diagram, businesses obtain revenue through the _____ market and make expenditures in the _____ market.

A product; financial

B resource; product

C product; resource

D capital; product

C product; resource

slide16

4) Since World War II:

A North Korea's command economy has significantly outperformed South Korea's market economy.

B South Korea's command economy has significantly outperformed North Korea's market economy.

C North Korea's market economy has significantly outperformed South Korea's command economy.

D South Korea's market economy has significantly outperformed North Korea's command economy.

D South Korea's market economy has significantly outperformed North Korea's command economy.