Chapter 2. Section 1: Answering 3 Economic Questions Different economic systems have evolved in response to the problem of scarcity the method used by.

Chapter 2

Section 1: Answering 3 Economic Questions Different economic systems have evolved in

response to the problem of scarcity the method used by a society to produce and

distribute goods and services Three economic questions

What goods and services should be produced? Satisfy society’s needs and wants Guns and butter trade-off

How should goods and services be produced?

Who consumes goods and services? Determined by how societies choose to distribute

income Factor payments are the income people receive

for supplying factors of production Landowners get rent Workers receive wages

Economic Goals

Economic efficiency Societies try to maximize what they can get for

the resources they have to work with If a society can accurately assess what to

produce, it increases economic efficiency Manufacturers won’t make records if everyone is

buying CDs

Economic freedom Economic systems of different nations allow

different degrees of economic freedoms Ability to make own choices

Economic Security and Predictability Economic systems reassure people that goods

and services will be available when they need them and they can count on receiving expected payments on time

Government should provide a safety net- government programs that protect people experiencing unfavorable economic conditions

Economic Equity Society must decide the best way to divide the

economic pie Should everyone get the same or should one’s

consumption depend on how much one produces? Equal pay for equal work? Society does not value all

jobs equally

Economic growth and innovation Nation’s economy must grow for a nation to improve its

standard of living Level of economic prosperity

Additional goals Environmental protection Full employment Universal medical care Etc. Must prioritize goals

Four Economic Systems

Traditional economies relyon habit, custom, or ritual todecide what to produce, howto produce it, and to whom todistribute it.

In a market economyeconomic decisions are madeby individuals and are basedon exchange, or trade.

In a centrally plannedeconomy the centralgovernment makes alldecisions about the productionand consumption of goodsand services.

Mixed economies aresystems that combine traditionand the free market withlimited governmentintervention.

Chapter 2, Section 1Chapter 2, Section 1

An economic system is the method used by a society to produce and distribute goods and services.

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Section 2: The Free Market

A market is an arrangement that allows buyers and sellers to exchange things

Why markets exist Specialization- the concentration of the

productive efforts of individuals and firms on a limited # of activities

Makes us more efficient- easier to learn one task or a few tasks than to learn them all

Buying and selling- we need markets to sell what we have and to buy what we need

Free market economy Individuals answer the three economic questions

Shows how individuals and businesses exchange money, resources, and products in the marketplace

Households and firms Households own the

factors of production (land, labor, capital)

Also the consumers of goods and services

A business, or firm, uses resources to produce a product, which it then sells.

Firms transport “inputs,” or the factors of production, into “outputs” or products.

Households pay firms for goods and services.

Firms supply households with goods and services.

Households supply firms with land, labor, and capital.

Firms pay households for land, labor, and capital.

The factor market is where firms purchase the factors of production from households Rent land, hire workers, pay wages for labor

Profit is the financial gain made in a transaction

The product market is where households purchase the goods and services that firms produce

Self-Regulating Nature of the Marketplace Competition and our own self-interest keep

the marketplace functioning Self- Interest

Adam Smith Economy is made up of countless individual

transactions In each transaction, the buyer and seller consider

only their self-interest, or their own personal gain It is the motivating force in the free market

Competition Consumers have the incentive to look for a lower price

The hope or reward of the fear of punishment that encourages a person to behave in a certain way

Firms seek to make greater profits by increasing sales While self-interest is the motivating force behind the

free market, competition is the regulating force Competition is the struggle among producers for the

dollars of consumers; the rivalry among sellers to attract customers while lowering costs

The Invisible Hand Self-interest and competition work together to

regulate the marketplace Self-interest spurs consumers to purchase certain

goods and services and firms to produce them Competition causes more production and moderates

price All this happens without any central plan or direction Adam Smith called this “the Invisible Hand”

Advantages of the Free Market

Economic Efficiency Self-regulating therefore it responds efficiently to rapidly

changing conditions Economic Freedom

Highest economic freedom of any system Workers work where they want, firms produce what

they want, individuals consume what they want Economic Growth

Competition encourages innovation and growth

Section 3: Centrally Planned Economies How is it organized?

Central gov’t, rather than individual producers and consumers, answers the key questions of production and consumption

What items to produce? How to produce them? Who gets them?

Government Control of Factor Resources Government owns land and capital In a sense, owns the labor too

Controls where people work and the wages they are paid

Directs workers on what to produce and how much to charge

Self-interest and competition are absent from the system

Socialism/ Communism

Often used interchangeably Socialism

Social and political philosophy based on the belief that democratic means should be used to distribute wealth evenly throughout a society

Real equality can only exist when political equality is coupled with economic equality

Socialism can be present in a democracy

Communism Political system that is characterized by a

centrally planned economy with all economic and political power resting in the hands of the central gov’t

Can only come from violent revolution Authoritarian- strict obedience from their citizens

and do not allow individuals freedom of judgment and action

Former Soviet Union

1917 Czar Nicholas II forced from throne Taken over by Bolsheviks led by Vladimir Lenin

Renamed themselves communists Murdered Czar and children

Central planning introduced Soviets concerned with building national power and

prestige Best land, labor, capital went to military, space program,

etc.

Soviet agriculture Created large state-owned farms and collectives State-run farms

Provided w/equipment, seed, fertilizer Workers worked for wages

Collectives Farms leased from the state to groups of peasant

farmers Farmers managed operations BUT had to produce

what the gov’t instructed Received a share of what they produced

Little incentive to work hard and produce better quality of goods

Soviet Industry State-owned factories Defense, space program, heavy industry were priorities Consumer goods were stuck with leftover, lower quality

resources to create their products Soviet Consumers

Consumer goods were scarce and usually of poor quality Often waited in line to purchase goods Some goods- like meat- were rarely available

Problems

Poor quality, serious shortages Almost always falls short of ideals upon which

the system is built Cannot meet consumers needs and wants Workers lack incentive to work hard Lacks flexibility to adjust to consumer demands Sacrifice individual freedoms in order to pursue

societal goals

Section 4: Modern Economies

Most modern economies are a mixture of economic systems Most blend the market with gov’t intervention, or

involvement, in the marketplace There has been a movement from less to

more gov’t involvement Laissez faire gov’t regulation How is the gov’t involved in our economy?

Government’s Role in a Mixed Economy In a mixed

economy,

Chapter 2, Section 4Chapter 2, Section 422 3311

Product market

the government purchases goods and services in the product market, and

Factor market

purchases land, labor, and capital from households in the factor market.

Comparing Mixed Economies

Chapter 2, Section 4Chapter 2, Section 4

An economic system that permits the conduct of business with minimal government intervention is called free enterprise. The degree of government involvement in the economy varies among nations.

Continuum of Mixed Economies

Centrally planned Free market

Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick

Iran

North Korea

Cuba

China

Russia Greece Peru United States

South Africa France United Kingdom

Botswana Canada Singapore

Hong Kong

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