Topic 2: Free Enterprise and Other Economic Systems.

Topic 2: Free Enterprise and Other Economic Systems

I. The Three Basic Economic Questions

• Because resources are scarce, every society must answer three economic questions:

• What goods/services should be produced?• How should these goods/services be produced?• Who consumes these goods/services?

• The way a society answers these questions defines its economic system.

Three Questions…

1. What Goods/ Services to Be Produced?* Every society must decide what to produce to satisfy needs/wants* Ex: food, shelter, consumer goods.* Each decision comes w/ opportunity costs

2. How Should Goods and Services Be Produced?* Ex: What fuel use? Oil, solar, nuclear?* Figure 2.1* All decisions involve trade-offs

Three Questions…

3. Who Consumes the Goods and Services that are produced?* Answers to should questions are largely determined by how

societies distribute income.* Factor Payments* Profit

I. Three Questions…

Economic Goals of Society1. Efficiency2. Freedom3. Security… safety net4. Equity… Figure 2.25. Growth… Standard of Living, Innovation6. Conflicting Economic Goals7. Traditional Economies

Which basic economic goals can be achieved easily in a traditional economy? Which cannot?

II. Free Markets

Why Do Markets Exist?1. Define: Markets

* Markets eliminate the need for self-sufficient

2. Role of Specialization* Leads to efficiency in the use of capital, land, and labor; benefits businesses and specialists

3. Buying and Selling* Need a mechanism that allows buying/selling that was produced and buy what they want.

II. Free Markets

Elements of a free Market Economy• Answers to the 3 ?s are made by voluntary exchange in

markets.• Individuals and businesses make their own decisions about

what to buy or sell.• Mkt Eco: sometimes called capitalist economies b/c the capital

that entrepreneurs invest is a vital part of system.• Role of Households/ Firms:• Role of Factor & Product Markets:

II. Free Markets

How Markets Self-Regulate• Self Interest & Adam Smith/ The Wealth of Nations• Incentives & Competition

Figure 2.5• The Invisible Hand

What does competition among producers in a free market accomplish for consumers?

II. Free MarketsAdvantages of a Free Market1. Economic Efficiency2. Economic Freedom3. Economic Growth4. Additional Goals

Note: Figure 2.6Consumer Sovereignty

III. Centrally Planned Economies

Features of Central Planning• Definition• Govt answers 3 ?s; owns land, capital, even labor• Contrast to a free market system• No free mkt forces of self-interest, incentives, and

competition.• Communism and socialism are two examples of

central planned economies.

III. Centrally Planned Economies

Socialism• Range of eco systems/

practices• Allows ownership of some

private property• Can be part of democratic

system

Communism• Requires revolutionary

change• Govt is authoritarian, not

democratic• State ownership of f of prod

III. Centrally Planned Eco: Socialism v. Communism

• Both: even distribution of wealth and centralized control of economic power.

• Note: Authoritarian, Karl Marx

Why does communism require an authoritarian govt? What belief did Karl Marx hold about capitalism?

Figure 2.8: Production Goals: Soviet 5 Year Plan

III. Centrally Planned Economies

Disadvantages of Central Planning1. Economic Inefficiency2. Lack of Economic Freedom3. Lack of Economic Growth4. Economic Inequity5. Additional Goals

Why do centrally planned economies tend not to be efficient? Who benefits and who suffers most from a centrally planned economy? How?

IV. Mixed Economies

I. The Reasons for a Mixed EconomyA. Why Govt Gets Involved

Laissez-faire; Private Property; Intellectual Property; Mixed EcoB. Balancing Govt and Eco Freedom

IV. Mixed Economies

II.Circular Flow Model of a Mixed Economy

IV. Mixed Economies… Circular Flow1. Govt Actions in the Factor Market2. Govt Actions in the Product Market3. Govt Actions Transferring Money

IV. Mixed Economies

C. Mixed Economies Today1. Mixed Eco w/ Heavy Govt Involvement2. Mixed Eco Tending Toward Free Markets3. Role of Govt4. Overall Economic Freedom

Note: Continuum on Mixed Economies: Figure 2.12

V. Benefits of Free Enterprise

A. Basic Characteristics of Free Enterprise1. Opportunity2. Incentives3. Profit Motive4. Competition; Open Opportunity 5. Legal Equality6. Private Property Rights7. Economic Freedom: Free contract, voluntary

exchange

V. Benefits of Free Enterprise

B. Key Roles in the Free Enterprise System1. Role of the Consumer: interest group2. Role of the Entrepreneur

C. Economic Freedom and the Constitution1. Property Rights: eminent domain; 5th A2. Taxation: 16th A3. Contracts

V. Benefits

D.Limited Role of Govt in the Marketplace** Constitutional responsibility to protect property rights

evolved into actions to promote the public interest.1. Information & Free Enterprise: public disclosure laws2. Protecting Public Health, Safety, and Well-being3. Negative Effects of Regulation

How would the right of voluntary exchange be undermined if Congress overturned all public disclosure laws regarding the car industry?

Important Terms

Macroeconomics: study of economic behavior and decision-making in a nation’s whole economy.

Microeconomics: study of economic behavior and decision making in small units (households, firms)

Gross Domestic Product: total value of all final goods and services produced annually in a country.

Business Cycle: the alternating pattern of periodic expansion and contraction (Figure 2.6)

Public Good: shared good or service (infrastructure); financed by the public sector.