Economic Systems

1. Economic Systems Mr. Bordelon Economics

2. What is an economic system? • Economic system. The method by used by a society to produce and distribute goods and services. • Great. But how? • Every economic system must answer specific questions about production.

3. Three Economic Questions • What goods and services should be produced? • What are we going to make? • How should these goods and services be produced? • How are we going to make it? • Who consumes these goods and services? • Who’s going to buy this stuff?

4. Economic Systems and Values Every economic system reflects the priorities of different economic goals, as well as the values of that particular society. Traditional economiesrely on habit custom, or ritual to decide the three economic questions. Centrally-planned economies, or command, the government makes all decisions about production and consumption of g/s. Market economies, economic decisions are made by individuals based on trade. Mixed economiescombine tradition and free market with limited government intervention.

5. Questions 1. Each society determines who will consume what is produced based on • its unique combination of social values and goals. • the amount of factor payments. • its needs and wants. • economic equity. • Which of the following is not a key economic question? • What goods and services should be produced? • How should these goods and services be produced? • At what price should these goods and services be set? • Who will consume these goods and services?

6. Questions 1. Each society determines who will consume what is produced based on • its unique combination of social values and goals. • the amount of factor payments. • its needs and wants. • economic equity. • Which of the following is not a key economic question? • What goods and services should be produced? • How should these goods and services be produced? • At what price should these goods and services be set? • Who will consume these goods and services?

7. Free Market • What have you bought today?

8. Free Market • Why didn’t you make it yourself?

9. Free Market • All the factors of production belong to individuals and businesses. • So...who makes the decision about the three key economic questions?

10. Free Market • All the factors of production belong to individuals and businesses. • So...who makes the decision about the three key economic questions? • Individuals and businesses. No government intervention at all.

11. Free Market • Markets exist because nobody produces all the g/s we require to satisfy our needs and wants. (Hmmmm, what is that called again?) • So we specialize in making a certain product and trade it. • Market. An arrangement that allows buyers and sellers to exchange goods and services. • Specialization. Concentration of productive efforts of individuals and firms on a limited number of activities. Focus on a particular thing, especially one we’re good at.

12. Free Markets Run Themselves • Free markets run themselves, or are self-regulating. • Okay, great, what does that mean?

13. Free Markets Run Themselves • So wait, if the markets run themselves, who tells people (producers) what to make? • Or even better, how do we (consumers) know which product to buy?

14. Self-Interest • In every single transaction, buyers and sellers look only at their self-interest—their own personal gain. Self-interest is what motivates buyers and sellers in the free market. • So...does that mean we’re selfish? • What do you think?

15. Self-Interest • Reality is that self-interest is not about selfishness. Selfishness is about morality, ethics. Here, we’re talking solely about benefit. • We assume that people will not act against their own interests. • Seller’s interests? • Buyer’s interests?

16. Self-Interest • Question: do we act against our own self-interests in reality?

17. Competition • Competition. Struggle among producers for the dollars of consumers. • Think about the self-interest of sellers. • Each seller wants people to buy their product, and not someone else’s. How would we do this?

18. Competition • Competition. Struggle among producers for the dollars of consumers. • Think about the self-interest of sellers. • Each seller wants people to buy their product, and not someone else’s. How would we do this? • Innovation—making a better product. • Marketing and advertising— “My product’s better!” • Sales, etc.

19. Communication BetweenBuyers and Sellers • So...how do buyers send the message to sellers that they want or don’t want a particular product? • How do sellers sent the message to buyers to buy or not buy a particular product?

20. Communication BetweenBuyers and Sellers • So...how do buyers send the message to sellers that they want or don’t want a particular product? • How do sellers sent the message to buyers to buy or not buy a particular product? • The answer of course is that they don’t communicate directly, but indirectly: buying stuff!

21. Invisible Hand • Adam Smith in The Wealth of Nations focused on self-interest and this “communication.” • Buyer and seller consider only their self-interest. • Consumers are going to buy only g/s they want, and no producer is going to make something no one wants to buy. • Competition helps create more and better products at lower prices. • Consumers get the products they want at the price they want to buy them for.

22. Invisible Hand • All this happens without any kind of coordination between buyers and sellers. • Adam Smith called this the “invisible handof the marketplace.” • EOC: Know Adam Smith and “invisible hand.”

23. Advantages of the Free Market Efficiency. As a self-regulating system, a free market economy is efficient. Growth. Free markets encourage growth because competition encourages innovation. Freedom. Of all systems we’ll study, free market economies have the highest degree of economic freedom. Variety. Wider variety of g/s than other economic systems.

24. Disadvantages of the Free Market • Are there any? • Go back to the three economic questions.

25. Circular Flow Diagram of a Market Economy Households pay firms for goods and services. monetary flow physical flow Firms supply households with goods and services. Households supply firms with land, labor, and capital. Households Firms physical flow Firms pay households for land, labor, and capital. monetary flow The Free Market Economy • In a free market economy, households and business firms use markets to exchange money and products. Households own the factors of production and consume goods and services. • Product Market. Guess what we sell here.  Households are going to give money to firms to buy g/s. (monetary flow) Firms supply households with g/s. (physical flow) Product market Factor market

26. Circular Flow Diagram of a Market Economy Households pay firms for goods and services. monetary flow physical flow Firms supply households with goods and services. Households supply firms with land, labor, and capital. Households Firms physical flow Firms pay households for land, labor, and capital. monetary flow The Free Market Economy • Factor Market. “Factor” is another name for “resource.” Where have we seen “factor” used before? • On the factor side, firms are going to buy land, labor and capital from the households (monetary flow), and households are going to supply firms with land, labor and capital (physical flow). Product market Factor market

27. Circular Flow Diagram of a Market Economy Households pay firms for goods and services. monetary flow physical flow Firms supply households with goods and services. Households supply firms with land, labor, and capital. Households Firms physical flow Firms pay households for land, labor, and capital. monetary flow The Free Market Economy • Monetary flow. Households buy g/s from firms. Firms buy factors of production from households. • Physical flow. Firms provide g/s to households. Households provide factors of production to firms. Product market Factor market

28. Questions • Why do people need to buy and sell goods and services? • People need to buy and sell goods to make a profit. • People buy and sell to maintain a competitive society. • No one is self-sufficient. • People need to provide the market with goods and services. • What factors create the phenomenon of the “invisible hand”? • incentives and efficiency. • specialization and efficiency. • competition between firms. • competition and self interest.

29. Questions • Why do people need to buy and sell goods and services? • People need to buy and sell goods to make a profit. • People buy and sell to maintain a competitive society. • No one is self-sufficient. • People need to provide the market with goods and services. • What factors create the phenomenon of the “invisible hand”? • incentives and efficiency. • specialization and efficiency. • competition between firms. • competition and self interest.

30. Centrally-Planned Economies • In centrally-planned economies, the government owns all the land and the capital. • So...if that’s the case, who makes the decision on the three key economic questions?

31. Centrally-Planned Economies • In centrally-planned economies, the government owns all the land and the capital. • So...if that’s the case, who makes the decision on the three key economic questions? • The government decides what to produce, how much to produce, and how much to charge.

32. Socialism vs. Communism Socialism Communism Political system characterized by a centrally-planned economy with all economic and political power resting in the hands of the government. • Social and political philosophy based on belief that democratic means should be used to distribute wealth evenly throughout a society.

33. Karl Marx • Author of The Communist Manifesto. • Coined the term “communist.” • His economic philosophy stated that there is intrinsic value in labor (provided more often by poor workers), and that it is much more valuable than capital (provided by the wealthy, known as the bourgeoisie). • Marx believed that government should be in the hands of the collective, led by workers, and not capitalists. • His work formed the economic basis of communist countries like the Soviet Union. • EOC: Be familiar with Karl Marx.

34. Advantages of aCentrally-Planned Economy • Concentration of Production. Centrally-planned economies can focus all of their production on one particular industry as necessary. • When especially can this be a good thing?

35. Disadvantages of aCentrally-Planned Economy • Concentration of Production. Centrally-planned economies can focus all of their production on one particular industry as necessary. • To the exclusion of everything else. • Poor-quality goods, shortages, slow production. • Its major advantage is also its major disadvantage.

36. Questions • In a socialist country, • central planning is unnecessary. • the government often owns major industries, such as utilities. • an authoritarian government controls the economy. • economic equality is not important. • Which of the following is an advantage of a centrally-planned economy? • the system’s bureaucracies are small and flexible. • the system can work quickly to accomplish specific goals. • innovation is well rewarded. • consumers’ needs are well met.

37. Questions • In a socialist country, • central planning is unnecessary. • the government often owns major industries, such as utilities. • an authoritarian government controls the economy. • economic equality is not important. • Which of the following is an advantage of a centrally-planned economy? • the system’s bureaucracies are small and flexible. • the system can work quickly to accomplish specific goals. • innovation is well rewarded. • consumers’ needs are well met.

38. Mixed Economies • Market economies are not perfect. They come with substantial drawbacks. Individuals and businesses control everything. That is not bad in and of itself, but there’s a conflict. • Laissez-faire. Government generally should not interfere in the marketplace. Adam Smith (may show up on EOC). • What are the interests of individuals? • What are the interests of corporations?

39. Mixed Economies • The basic self-interest of a business is to make money. Taken to the extreme, that means to make money at any cost. • And this has led to certain problems.

40. Mixed Economies • The modern belief is that government does, and should have some role to play in the economy. • Governments create laws protecting property rights and enforcing contracts, in court if necessary. They also encourage innovation through patent and intellectual property laws. • In the U.S., it’s so important that we’ve enshrined it in the Constitution.

41. Now, don’t panic. • Remember that Circular Flow Diagram we made for a Free Market economy? • We’re going to make a new one, but add one actor: the government. • Take a moment to draw your circular flow diagram, but leave space in the center.

42. Circular Flow Diagram of a Mixed Economy monetary flow physical flow taxes government purchases Government expenditures expenditures Firms Households government-owned factors taxes physical flow monetary flow Government’s Role in a Mixed Economy In a mixed economy, • The rules on product and factor markets stay the same. • The monetary and physical flows stay the same. Product market Factor market

43. Circular Flow Diagram of a Mixed Economy monetary flow physical flow taxes government purchases Government expenditures expenditures Firms Households government-owned factors taxes physical flow monetary flow Government’s Role in a Mixed Economy In a mixed economy, • Product market. The government purchases g/s from firms. They receive taxes from households. • Factor market. The government purchases the factors of production from households. They receive taxes from firms. Product market Factor market

44. Circular Flow Diagram of a Mixed Economy monetary flow physical flow taxes government purchases Government expenditures expenditures Firms Households government-owned factors taxes physical flow monetary flow Government’s Role in a Mixed Economy In a mixed economy, • Monetary Flow. Transactions between households and firms are taxed by the government. • Physical Flow. Government receives g/s from firms, and factors of production from households. Product market Factor market

45. Circular Flow Diagram of a Mixed Economy monetary flow physical flow taxes government purchases Government expenditures expenditures Firms Households government-owned factors taxes physical flow monetary flow Government’s Role in a Mixed Economy • Expenditure. Another word for expenditure is “spending.” It’s an economic term you need to recognize. • The government provides expenditures to both business and firms. The expenditures come from taxes collected. • Government transfer the money from taxes to households and businesses for a variety of reasons. • Like what? Product market Factor market

46. Circular Flow Diagram of a Mixed Economy monetary flow physical flow taxes government purchases Government expenditures expenditures Firms Households government-owned factors taxes physical flow monetary flow Government’s Role in a Mixed Economy • Expenditure. Another word for expenditure is “spending.” It’s an economic term you need to recognize. • The government provides expenditures to both business and firms. The expenditures come from taxes collected. • Government transfer the money from taxes to households and businesses for a variety of reasons. • Social Security • Medicaid • Tax breaks for businesses Product market Factor market

47. Questions • The United States economy is a mixed economy (a) based on the principle of a traditional economy, but allows some government intervention. • based on the principles of a centrally-planned economy, with limited government intervention. • based on the principles of the free market, and allows no government intervention. • based on the principles of the free market, but allows some government intervention. • Government intervention in a modern economy is useful because • the needs and wants of modern society are always met by the marketplace. • the marketplace has many incentives to create public goods such as parks and libraries. • governments are able to provide some goods and services that the marketplace has no incentive to produce. • the marketplace provides all of its own laws.

48. Questions • The United States economy is a mixed economy (a) based on the principle of a traditional economy, but allows some government intervention. • based on the principles of a centrally-planned economy, with limited government intervention. • based on the principles of the free market, and allows no government intervention. • based on the principles of the free market, but allows some government intervention. • Government intervention in a modern economy is useful because • the needs and wants of modern society are always met by the marketplace. • the marketplace has many incentives to create public goods such as parks and libraries. • governments are able to provide some goods and services that the marketplace has no incentive to produce. • the marketplace provides all of its own laws.