Chapter 2

Chapter 2 – Decision Making & Systems

ECONOMICSTHEORY AND PRACTICE

Seventh Edition

Copyright © 2004 John Wiley & Sons, Inc. All rights reserved.

Patrick J. WelchSt. Louis University

Gerry F. WelchSt. Louis Community

Collegeat Meramec

&

PowerPoint Presentation by:

Dr. Ray EverettPima Community College

Decision Making & Economic Systems

Contents

Basic Economic Decisions

Intro. to Economic Systems

Agrarian Economies

Market Economies

Planned Economies

Mixed Economies

Changing Economic Systems

The U.S. Economic System

Historical Highlights of the U.S. Economy

Decision Making & Economic Systems

Chapter Objectives• To introduce the basic economic choices that must be made in every

society because of scarcity.

• To describe differences among traditional, market, and planned economies, and how the basic economic choices are made in each of these systems.

• To explain how market economies are structured and how they operate.

• To explain why, where, and how government intervenes in mixed economies, chiefly the U.S. economy.

• To distinguish between capitalism and socialism and to describe how these two systems relate to individual and collective economic decisions.

• To discuss economic changes in Eastern Europe.

• To explore the British foundations and the historical highlights of the U.S. economy.

• Basic Economic Decisions Three important choices a society makes regarding the

production and distribution of goods and services.• What goods and services to produce and in what

quantities?– Everyone in society has endless wants, but only limited

varieties and amounts of consumer and capital goods can be produced.

• How to produce these goods and services, or how to use the economy’s resources?

– Products can be made in a number of different ways.

• Who gets these goods and services?– Focuses on distribution.

Basic Economic Decisions 2-1

Introduction to Economic Systems

• Economic System One of four ways to organize the

relationships among businesses, households, and the government within a society.

• Agrarian economies– Decision making is based on

tradition.

• Market economies– Decision making is made by buyers

& sellers through prices in marketplaces.

• Planned economies– Decision making is a collective

effort.

• Mixed economies– Combine market & planned systems.

2-2

FIGURE 2-1 Scarcity, the Basic

Economic Decisions, and Economic Systems

• Agrarian Economies Also called traditional economies. Rely on historical, social, political, or religious

arrangements or tradition to decide what to produce. Fairly small, close, and rural, and they often work to

support all members. Allocate a larger distribution of goods and services to

those with a defined social status within the society.

Agrarian Economies 2-3

Market Economies

• Market Economies Also called price systems. Rooted in the belief that decisions are best made by

individuals. Private property rights are essential to these systems. Ability to engage in

free enterprise, which is why market economies are often associated with capitalism.

A pure market economy can best be illustrated by using a circular flow chart.

2-4a

FIGURE 2-2The Circular Flow of Economic Activity

Market Economies

• Market Economies (cont.) Rely on millions of independent decisions by individual

households and businesses in the marketplace to determine what to produce.

Comprised of myriad businesses that usually utilize the least-cost method of production.

2-4b

Utilize the price system to determine who receives goods and services.

• People have access to goods and services only if they can pay for them, and their ability to pay is determined by the number and value of resources that they, the people, offer to businesses.

Market Economies

• Market Economies (cont.) Unparalleled opportunity for growth and change.

• Those born into poverty have the ability to transcend that barrier and ascend the economic ladder.

Lack of consideration given by some businesses when profit is a prime motive.

• Can lead to lower costs for businesses, but will lead to higher costs for society due to hazardous products or poor working conditions.

2-4c

Market Economies

• Government Intervention in Market Economies Society frequently turns to the government for help when

it wants to address market failures. Economies are no longer pure after such intervention.

2-4d

FIGURE 2-3Government Intervention in a Market Economy

Planned Economies

• Planned Economies Also called command economies. Rely on planning authorities to decide what to produce. Look to planning authorities to instruct enterprises on

how to produce various items. Trust in planning authorities to distribute goods and

services.

2-5

• Mixed Economies Economies in which decisions are addressed by some

combination of market and centralized decision making. Pure market and pure planned economies are used as a

basis, but neither have real-world counterparts, and neither are perfect in their design.

As market economies experience problems, they tend to move away from pure market to mixed economies, and as planned economies experience failures, they move away from pure planned to mixed economies.

Mixed Economies 2-6

FIGURE 2-4Continuum of Economic Decision Making

Changing Economic Systems

• Beginning in the mid-1980s, dramatic changes occurred in many of the world’s planned economies.

• The Soviet Union, Poland, Hungary, and other nations began moving toward greater use of free markets and individual decision making.

• Privatization allowed individuals to be granted property rights to factors of production that were once collectively owned, or owned by the state.

• Problems have arisen in the transition from planned economies to market economies due to economic problems that defy simple or obvious solutions.

• One lesson learned from these experiences is that, while the commitment to change may be professed quickly, change itself comes slowly.

2-7

The U.S. Economic System

• The U.S. economy has been described as a mixed economic system; one that primarily depends on markets and individual decisions, though some government intervention is also present.

• It came as a result of the transformation of England and Scotland into industrial market economies.

• This began with the rise of economic individualism.• In his book The Wealth of Nations in 1776, Scottish

philosopher Adam Smith proposed a new economic system called laissez-faire (let it alone) capitalism which challenged the reigning system of mercantilism in which the state was deemed to be the best judge of what is good for an economy.

• Central to Smith’s argument for a new economic system was his invisible hand doctrine.

2-8a

The U.S. Economic System

• According to his doctrine, people do not base their business dealing with others on altruism or benevolence. Rather, people carry on their business in a way that serves their own best interests.

• Smith explained that by pursuing one’s own best interest, one is guided “as if by an invisible hand” to advance the interests of all society.

• As this philosophy rose, the British world saw significant technological and social changes that are known today as the British Industrial Revolution.

• It spurred a series of inventions and innovations such as massive mechanical weaving looms and steam engines.

• These inventions led to changes in how goods and services were rendered.

2-8b

• Along with the progress made by England and Scotland between the 17th and 19th centuries, the evolution of the U.S. economy was brought about by several key events in the U.S:

Prior to the Civil War, the U.S. economy was primarily agricultural, but following the Civil War substantial and significant changes occurred due to an industrial boom experienced throughout the majority of the country.

With this boom in the economy came regulation of companies that were becoming large and might be able to monopolize markets.

Along with regulation of monopolies, the government intervened in other problems, such as the harsh living and working conditions.

The next round of government interventions would come in the form of the New Deal.

Highlights of the U.S. Economy 2-9a

Due to the stock market crash of 1929 and the following economic decline, the “New Deal” created a series of programs and legislative reforms instituted during the presidential administration of Franklin D. Roosevelt.

The next big intervention made by the government would come in the form of the Employment Act of 1946, which provided Congress with the ability to manipulate taxes and government spending in an effort to bring the economy to a desired level of activity.

Regulatory activities increased in the 1960s and the 1970s, until a deregulation trend developed in the late 1970s and continued in the 1980s as part of the Carter and Reagan administrations.

Since the 1980s, the federal debt has risen dramatically. By 2003 the debt exceeded $6.5 trillion, and the

regulatory activity trend was once again reversed.

Highlights of the U.S. Economy 2-9b

ECONOMICSTHEORY AND PRACTICE

Seventh Edition

Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the expressed written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Chapter 2 – Decision Making & Systems

This is the end of Chapter 2.

To return to the contents menu of this chapter, click on the menu graphic to the right of this text.

To begin Chapter 3, click on the next chapter icon to the right of this text.

Menu

NextChapter