Economic Systems

Types of Economic Systems

• Economic system:
• how society uses resources to satisfy people’s wants

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• Three basic systems:
• Traditional
• Command
• market economies

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Types of Economic Systems

• Traditional Economy
• centers on families, clans, or tribes
• decisions are based on customs and beliefs
• Good of the group always comes before individual desires

Characteristics of Traditional Economies

• Advantages and Disadvantages
• Advantages: little disagreement over goals, roles
• methods of production, distribution determined by custom
• Disadvantages: as result of resistance to change, less productive
• do not use new methods; people not in jobs they are best suited for
• low productivity results in low standard of living

Types of Economic Systems cont.

• Command Economy
• (centrally planned economy) government makes economic decisions
• determines what to produce; how to produce; who gets products
• determines who is employed, work hours, pay scales
• Wants of individual consumers rarely considered
• Government owns means of production: resources and factories

Government Controls

• EXAMPLE: Socialism and Communism
• Karl Marx influenced some societies to adopt command economies
• socialism—government owns some of the factors of production
• communism—no private property; little political freedom
• Authoritarian system requires total obedience to government
• communism is authoritarian socialism

Karl Marx: Economic Revolutionary

• A New View of Economics
• Marx lived during Industrial Revolution
• Argued factory owners used workers as resource
• exploited workers by keeping wages low to increase profits
• workers would rebel, establish classless society
• Wrote The Communist Manifesto (with Friedrich Engels), Das Kapital

Government Controls

• Socialism and Communism
• Democratic socialism established under democratic political process
• government owns basic industries
• other industries private
• central planners make decisions for government-owned industries
• central planners might control other sectors, such as health care

Command Economies Today

No pure command economies today

• modern telecommunications bringing about change
• Some economies still have mostly command elements

Command Economies Today

• North Korea
• Communist North Korea used resources for military, not necessities
• built large army; nuclear weapons program
• In 1990s and early 2000s, millions died of hunger, malnutrition
• In 1990s, production decreased and economy shrank
• Since 2003, some market activity allowed

Command Economies Today

• Impact of Command Economies
• In theory, command systems fair to everyone; In practice, many disadvantages
• central planners do not understand local conditions
• workers have little motivation to be productive or conserve resources
• artificially low prices lead to shortages
• people sacrificed to carry out centrally planned policies

Types of Economic Systems cont.

• Market Economy
• driven by choices of consumers and producers
• consumers spend money, go into business, sell their labor as they wish
• producers decide how to use their resources to make the most money
• Consumers, producers benefit each other when they act in self-interest

Fundamentals of a Market Economy

• 1: Private Property and Markets
• 2:Limited Government Involvement
• Laissez faire— government should not interfere in economy
• Capitalism—system having private ownership of factors of production
• says producers will create products consumers demand
• Actual market economies all have some government involvement

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Fundamentals of a Market Economy

• 3: Voluntary Exchange in Markets
• Voluntary exchange— traders believe they get more than they give up
• 4: Competition and Consumer Sovereignty
• Consumer sovereignty —buyers choose products, control what is produced
• Competition controls self-interested behavior
• sellers offer low price or high value to please consumers, make profit

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Fundamentals of a Market Economy

• 5: Specialization and Markets
• Specialization —people concentrate their efforts in the activities they do best
• encourages efficient use of resources
• leads to higher-quality, lower-priced products

Circular Flow in Market Economies

• KEY CONCEPTS
• Circular flow model illustrates how interactions occur in a market
• Represents the two key decision makers: households, businesses
• Shows the two markets where households and businesses meet
• goods and services
• resources

Circular Flow in Market Economies

• Factor Markets
• Factor market— market for the factors of production
• land, labor, capital, entrepreneurship
• Product Markets
• Product market— market where goods and services bought and sold
• includes all purchases by individuals from businesses

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Circular Flow in Market Economies

• Circular Flow
• Circular flow model shows how market economies operate
• outside arrow shows flow of money
• inside arrow shows flow of resources and products

Impact of Market Economies

• Advantages
• Individuals free to make economic choices, pursue own work interests
• Less government control means political freedom
• Locally made decisions mean better use of resources, productivity
• Profit motive ensures resources used efficiently, rewards hard work
• resulting competition leads to higher-quality, more diverse products

Impact of Market Economies

• Disadvantages
• Pure market economy has no way to provide public goods and services
• Does not give security to sick or aged
• During U.S. industrial boom, business owners rich, workers low pay
• Businesses did not address problems caused by industrialization
• Industrialized societies adopt some government control of economy

Today’s Mixed Economies

• Mixed economy
• has elements of traditional, command, market systems
• most common type of economic system
• Traditional, command, market economies adopt elements from others

Today’s Mixed Economies

• Life in a Mixed Economy
• Family farming in U.S. serves as example of mixed economy
• traditional: all members of family help bring in harvest
• command: affected by government—public school, roads, Social Security
• market: own land, sell their products in competitive market

Today’s Mixed Economies

• Types of Mixed Economies
• U.S. basically has market system
• European countries greater mix of market and command elements
• France—government controls some industries; provides social services
• Sweden—state owns part of all companies; lifelong benefits, high taxes
• Namibia—traditional; state supports market, foreign investment

Trends in Modern Economies

• Changes in Ownership
• Nationalize is to change from private to government ownership
• Privatize is to change from government to private ownership