Economic Systems and Decision Making Review! What 3 questions must every economy try to answer? What goods and services should be produced? How should.

Economic Systems and Economic Systems and Decision MakingDecision Making

Review! What 3 questions must every economy try to answer?

What goods and services should be produced? How should these goods and services be produced? Who consumes these goods and services?

All economic systems try to answer these Q’s Cuba: Cosmetic surgery NOT available—government

refuses to allow resources to be used on this service You don’t have to live like a refugee!

4 Types of Economic Systems4 Types of Economic Systems Traditional economies rely on habit, custom, or

ritual to decide what to produce, how to produce it, and to whom to distribute it

In a centrally planned economy/command economy the central government makes all decisions about the production and consumption of goods and services

In a market economy economic decisions are made by individuals and are based on exchange, or trade. AKA “Laissez-faire economy” (“allow them to do” or more simply, leave it alone)

Mixed economies are systems that combine tradition and the free market with limited government intervention.

Traditional EconomyTraditional EconomyIn a traditional economy, roles and

economic decisions are defined by customTraditional economies rely on habit,

custom, or ritual to decide what to produce, how to produce it, and to whom to distribute it

Examples: Canadians living in NunavutAdvantages: Everyone knows which role to

play, little certainty about what, how, or for whom to produce

Disadvantages: Discourages new ideas, new ways of thinking. LOW Standard of living

Command EconomyCommand EconomyIn a centrally planned economy/command

economy the central government makes all decisions about the production and consumption of goods and services

Found in North Korea, Cuba, China, VietnamEx: Cosmetic surgery is illegal in CubaAdvantages: Can drastically change

direction quickly, little uncertaintyDisadvantages:Consumer needs are not

met, hard work is not rewarded, decision making is delayed, has little flexibility, individual initiative is not rewarded, NO INCENTIVES!!!!!!

Problems of a Centrally Planned EconomyProblems of a Centrally Planned Economy

Centrally planned economies face problems of poor-quality goods, shortages, and diminishing production.

The Former Soviet UnionThe Former Soviet UnionSoviet Agriculture

– In the Soviet Union, the government created large state-owned farms and collectives for most of the country’s agricultural production.

Soviet Industry– Soviet planners favored heavy-industry

production (such as steel and machinery), over the production of consumer goods.

Soviet Consumers– Consumer goods in the Soviet Union were

scarce and usually of poor quality.

The USSR Under Lenin & StalinThe USSR Under Lenin & Stalin

Lenin took large estates from the rich and gave them to the peasants, while outlawing private property

Factories were turned over to workers Workers lacked skill, so New Economic

Policy was instituted (Capitalism) Stalin’s 5-Year Plans were

industrialization at any cost Stalin instituted collectivization,

particularly on farms

The USSR after StalinThe USSR after Stalin

The Communist Party and Gosplan, the central planning authority, ran just about everything without any local input

The agricultural sector was a problem—Khrushchev’s “Virgin Lands” failed and the USSR imported grain from the U.S.

Finally, the people demanded better consumer goods, and more of them

Gorbachev’s “perestroika” and “glasnost” provided opportunities to criticize and reform the economic system

Transition in RussiaTransition in Russia1. Communism in Russia--The Soviet government

reorganized farmland into state farms and collective farms. Much of the economy was focused on the growth of heavy industry.

2. Glasnost and Perestroika--In the late 1980s, Soviet Premier Mikhail Gorbachev introduced new reforms. Glasnost was a policy of "openness" encouraging open speech. Perestroika called for a gradual change from a centrally planned economy to free enterprise.

3. Collapse of Communism--In 1991, Russians voted in their first democratic election. Soon after, the Soviet republics declared themselves independent nations. By the end of 1991, the Soviet Union ceased to exist.

4. Transition to a Free Market--Since 1991, the Russian government has moved Russia towards free enterprise. However, extensive corruption and government mismanagement have hindered Russia's progress.

Socialism and CommunismSocialism and Communism Socialism is a social and political philosophy

based on the belief that democratic means should be used to distribute wealth evenly throughout a society. EX: Sweden

Benefits: Better distribution of benefits Disadvantages: Lower efficiency, high taxes,

entrenched special interests

Communism is a political system characterized by a centrally planned economy with all economic and political power resting in the hands of the government. EX: Cuba, China (neither a great example)

Advantage: Economy can shift quickly, lack of uncertainty.

Disadvantage: Poorly meets consumers’ needs

Free Market CapitalismFree Market Capitalism Producers and consumers determine

how/what/for whom to produce. Each consumer’s dollar is an “economic vote.”

Examples: United States, Canada, Western Europe, Japan, South Korea, Singapore

Advantages: Can adjust to change, gives a high degree of individual freedom, small degree of government involvement, consumers have a say in the economy, leads to a wide variety of goods and services (think of how many brands of dog food there are), and leads to high levels of consumer satisfaction (more tattoos than pocket squares right now)

Disadvantages: More uncertain for individuals. Unemployment and inflation do happen regularly.

Price TheoryPrice Theory(Important Component of Free (Important Component of Free

Market)Market) Output in a free market is decentralized. You will work for wages. These wages represent

income--the amount of money a household earns in a year.

Wealth is the accumulation of of past income or inheritances.

Wage rates determine the rewards for working in different jobs and professions.

The basic coordinating mechanism in the economy is price.

Individuals will pursue their own self-interest, motivated by profit, and produce what people want.

Others will acquire skills and buy, save, or invest the income they earn. Price is the determinant.

The ContinuumThe Continuum Parts of the US economy are almost completely

unregulated (Internet), but the Constitution permits Congress to regulate any interstate commerce—which since the 1930s has meant practically everything

During World War II, the government limited production of goods such as washing machines, refrigerators, and automobiles so the resources used to produce those goods could be funneled to different industries (food, armaments, etc).

Western Democracies vary widely in their level of capitalism. Sweden is Socialist, Singapore is almost unbridled capitalism

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

Making the TransitionMaking the Transition

Privatization in Eastern Europe and Russia has been difficult.

No Civil Society exists, and distributing government owned property evenly is difficult

In addition, there is little understanding by the populace of free market economy values

Eastern Germany has probably done the best, with Poland a close second.

Critical Thinking QuestionCritical Thinking Question

In the 1990s, many Eastern European countries moved from command to market economies.

1) HST link: What political developments made this possible?

2) What problems did people in these countries face as the made the change?

Section 1 ReviewSection 1 Review1. In a socialist country,

– (a) central planning is unnecessary.– (b) the government often owns major industries, such

as utilities.– (c) an authoritarian government controls the

economy.– (d) economic equality is not important.

2. Which of the following is an advantage of a centrally planned economy?– (a) The system’s bureaucracies are small and flexible.– (b) The system can work quickly to accomplish

specific goals.– (c) Innovation is well rewarded.– (d) Consumers’ needs are well met.

Did You Know?Did You Know?

The Fair Labor Standards Act of 1938 set the nation’s minimum wage at 25¢.

Debate has raged for years about what an acceptable minimum wage should be—should it be a “living wage?”

The answer to questions like this depends on a society’s economic goals.

Economic GoalsEconomic Goals Economic Freedom—Little government intervention

in the production and distribution of goods and services, allows people to make their own economic decisions

Economic Stability—avoiding wide swings in prices, wages, unemployment, etc.

Economic Equity—fair distribution of wealth (has not been achieved in US)

Economic Equality—everyone has equal opportunity to participate in free market, buying and selling

Economic Security and Predictability--Assurance that goods and services will be available, payments will be made on time, and a safety net will protect individuals in times of economic disaster (Welfare, FDIC)

More Economic GoalsMore Economic GoalsEconomic Growth and Innovation--

Innovation leads to economic growth, and economic growth leads to a higher standard of living.

Economic Efficiency-Making the most of resources

Other goals: Environmental Protection, Using Economics to reach political/military goals (US selling grain to USSR in 1970s to coerce USSR into behaving better)

Full Employment—providing as many jobs as possible. (See next slide)

UnemploymentUnemployment

It’s impossible for every member of the workforce to be employed. Bad times often coincide with market failure-- a situation in which the market, on its own, does not distribute resources efficiently

Rate is higher among non-whites and males Frictional and structural unemployment: Frictional: between jobs Structural: you don’t have necessary skills Full employment: ~4.5% unemployment During World War II, 1% unemployment--

overemployment

Group ActivityGroup Activity In groups of 4, take on the role I assign you and

decide what the US’s economic goals should be. Roles: CEO of large company, middle-aged Single mother on welfare Teenagers College Student Environmental activist Elderly couple YUPpy couple We will discuss these with 15 mins left Key Concept: Which economic goals conflict?

Competition and Free Competition and Free EnterpriseEnterprise

Capitalism is a market economy in which private citizens own the factors of production. In a free enterprise system, there is limited government interference and businesses are free to compete, within reason (NO monopolies though)

During voluntary exchanges, buyers and sellers are free to decide whether or not to complete transactions. To complete a transaction, both must usually agree that the good or service obtained is of more value than the money or product given up

Private property rights give people the motivation to succeed because they can keep rewards they earn

The profit motive encourages entrepreneurship Competition helps lower prices and improve

allocative efficiency

Economic systems have 2 parts:Economic systems have 2 parts:

Public sector Government spending/investments

A public good is a shared good or service for which it would be impractical to make consumers pay individually and to exclude nonpayers.

EX: Government buys F-22 fighters Quasi-Public goods are either

contestable or price-excludable EX: Government funds Amtrak; you

may decide not to ride EX: Mackinac Bridge toll

Private Sector

Consumer spending

EX: You buy any product or service

The Free-Rider ProblemThe Free-Rider Problem

A free rider is someone who would not choose to pay for a certain good or service, but who would get the benefits of it anyway if it is provided as a public good.

EX: You don’t want money spent on a new highway, but when it’s built, you use it during your commute to work

Answer: Fee-based system

The Role of Economic Participants in The Role of Economic Participants in CapitalismCapitalism

Entrepreneurs use land, capital, & labor to make profits

The consumer has much power in a free market economy. Consumers influence producers through their buying decisions. Consumers influence the government’s economic policies through voting and other techniques. People in 2001 wanted a tax cut, less spending, elected George W. Bush

Both consumers and producers are dependent upon each other.

EX: Consumer desires size 16.5- 38 dress shirts. Entrepreneur may decide tall people don’t represent much of a market, so the entrepreneur won’t make tall dress shirts. If entrepreneurs want to sell product, however, they must offer clothing that fits.

But what is the role of government???????????????

The Role of GovernmentThe Role of Government What is government’s role in a capitalistic society? Answer: Depends on your political orientation Liberals: Favor big, all-powerful government, protect

environment and less pro-business Conservatives: “the government that governs least

governs best,” preserve initiative, reward success, sink or swim on your own

DO NOT confuse with “economic liberal”: favors free trade, government noninterference, laissez-faire

Laissez faire is the doctrine that government generally should not interfere. Americans have traditionally favored economic freedom over economic regulation

Governments create laws protecting property rights and enforcing contracts. They also encourage innovation through patent and copyright laws.

Patent=allows you to exclusively produce an invention. Copyright=intellectual and artistic work protection

Japan’s “Role of Japan’s “Role of Government”Government”

Japan is an advanced Western Capitalistic society But its government is much more active in the

economy that many capitalist governments Japan’s early success was due to management style

and willingness to embrace technology The government enacted Protective Tariffs to help

these industries develop, but it never got rid of them. Japan’s economy is closed by non-tariff barriers as well.

Protectionism in Japan, however, is hurting consumers and the Japanese economy

A 1990s banking crisis has still not been dealt with. The Japanese economy has been sick since 1990-91.

Policy and Technology ReviewPolicy and Technology Review

1. Policymakers encourage all of the following EXCEPT– (a) stable productivity.– (b) high employment.– (c) stable prices.– (d) steady growth.

2. The government encourages advances in technology

and improvements in productivity by– (a) maintaining steady price controls.– (b) funding research and development projects at

many levels.– (c) hiring more workers to reduce unemployment.– (d) regulating banks and other financial institutions.

Government’s Role in a Mixed EconomyGovernment’s Role in a Mixed Economy

Market economies, with all their advantages, have certain drawbacks. In a mixed economy, the government purchases goods and services in the product market, and purchases land, labor, and capital from households in the factor market.

Product market

Factor market

Protecting Health, Safety, and Well-Protecting Health, Safety, and Well-BeingBeing

Many federal agencies regulate industries whose goods and services affect the well-being of the public.

Consumers are also aided by public disclosure laws, which require companies to give consumers full information about their products.

Major Federal Regulatory AgenciesAgency and Date Created Role

1906 Food and DrugAdministration (FDA)

Sets and enforces standards for food, drugs,and cosmetic products

Enacts and enforces antitrust laws to protect consumers

1914 Federal Trade Commission (FTC)

Regulates interstate and international communications by radio, television, wire, and satellite, and cable

1934 Federal Communications Commission (FCC)

Regulates civil aviation, air-traffic and piloting standards, and air commerce

1958 Federal Aviation Administration (FAA)

Promotes equal job opportunity through enforcement of civil rights laws, education, and other programs

1964 Equal Employment Opportunity Commission (EEOC)

Enacts policies to protect human health and the natural environment

1970 Environmental Protection Agency (EPA)

Enacts policies to save lives, prevent injuries, and protect the health of workers

1970 Occupational Safety and Health Administration (OSHA)

Enacts policies for reducing risks of harm from consumer products

1972 Consumer Product Safety Commission (CPSC)

Regulates civilian use of nuclear products1974 Nuclear Regulatory Commission

Fiscal RedistributionFiscal Redistribution• Def’n: “Robin hood”: Taking money from the wealthier

members of society and giving it to less well-off members in a variety of different ways

• The poverty threshold is an income level below that which is needed to support families or households.

• The poverty threshold is determined by the federal government and is adjusted periodically. Currently $20,000 for a family of 4.

• US poverty is RELATIVE poverty, much of the world is ABSOLUTE.

• # OF POOR IN WORLD HAS ACTUALLY DECLINED SINCE 1980• Welfare is a general term that refers to government aid to the

poor. • Welfare is funded by taxing the non-poor. Cash redistribution is

usually in the form of transfer payments

Redistribution ProgramsRedistribution Programs 1. Temporary Assistance for Needy Families

(TANF) This program allows individual states to decide

how to best use federally provided funds. 2. Social Security  Social Security provides direct cash transfers of

retirement income to the nation's elderly and living expenses to the disabled.

3. Unemployment Insurance Unemployment compensation provides money to

eligible workers who have lost their jobs. 4. Workers' Compensation Worker's compensation provides a cash transfer

of state funds to employees injured while on the job.

Other Redistribution Other Redistribution ProgramsPrograms

Besides cash transfers, other redistribution

programs include:

•In-kind benefits In-kind benefits are goods and services

provided by the government for free or at greatly reduced prices. (Free school lunches)

•Medical benefitsHealth insurance is provided by the

government for the elderly and disabled (Medicare) and for poor people who are unemployed or are not covered by their employer’s insurance (Medicaid).

•Education benefitsFederal, state, and local governments all

provide educational opportunities for the poor.

Government Involvement Government Involvement QuizQuiz

1. Welfare includes all of the following EXCEPT– (a) Temporary Assistance to Needy Families.– (b) Occupational Safety and Health Administration.– (c) Social Security.– (d) Medicaid.

2. Education programs make the economy more productive by– (a) adding to human capital and labor productivity.– (b) reducing taxes.– (c) providing more jobs in manufacturing.– (d) reducing injuries on the job.

Fiscal and Monetary PolicyFiscal and Monetary Policy Government can affect the performance of the economy

and the allocation of resources. It can: Impose TAXES (luxury tax on yachts, gas guzzler tax on

Vipers, “Sin tax” on cigarettes Outlaw certain products Spend more or less (change FISCAL POLICY) Alter the amount of money in the economy (MONETARY

POLICY)

A business cycle is a period of macroeconomic growth followed by a period of contraction. Government can adjust interest rates to stave off recession or inflation

We will revisit all of these concepts later

ExternalitiesExternalities An externality is an economic side effect of a good or

service that generates benefits or costs to someone other than the person deciding how much to produce or consume. Often the result of incomplete property rights (Who owns the air?)

Property rights must be 1) Clearly defined 2) Well-enforced 3) Transferable

EX: Chemical company produces DDT, dumps waste into river.

But externalities can be positive EX: “Anchor stores” in malls generate traffic. As a

result, they often pay zero rent! EX: Bees benefit more than beekeepers—beekeepers

and orchard owners can work together. Symbiotic relationship is necessary.

The goal: Marginal social benefits = Marginal social cost

Save the Whales ActivitySave the Whales Activity

Externalities: An ExampleExternalities: An Example The building of a new dam/creation of a lake

generates:

Positive Externalities ·      a possible source of hydroelectric power ·      swimming ·      boating ·      fishing ·      lakefront views 

Negative Externalities ·      loss of wildlife habitat due to flooding ·      disruption of fish migration along the river ·      overcrowding due to tourism ·      noise from racing boats and other watercraft

Critical Thinking QuestionCritical Thinking Question What would be some positive externalities and

negative externalities of a city deciding to permit Dow Chemical to build a brand new manufacturing facility?

Positive: Jobs, tax revenue for the city, property values might increase (due to need for housing workers—shortage)

Negative: Pollution, health problems, property values may decrease

Government tries to encourage positive externalities (subsidies for ethanol) and limit negative externalities (taxation) to avoid an underallocation or overallocation of resources

Think about this…Think about this…

The market system we have in the United States is so efficient that…

We make things like Beanie Babies—that

we don’t even use! 98% of the poor own a color TV

In a capitalistic system, the only way I can become wealthy is by improving everyone else’s standard of living.