Chapter 2: Economic Systems
Section 1: Types of Economic System
- Nations Make choices in order to use their natural, human, capital and entrepreneurial resources efficiently.
- A nation's response to the 3 basic economic questions (How to produce? - What to produce? -For whom to produce?) are determined by its economic system.
- An economic system reflects the process a nation follows to produce goods and services.
Four Types of economic systems:
1- Traditional 2- Command 3- Market 4- Mixed
In truth all economies are mixed.
1. Traditional Economics:
It's based on society's values -its customs and tradition.-
-The answers of the three economic questions are found in the past (rituals, habits, religious belief).
-Children often carry on the economic roles played by their parents; example: fishing.
-Customs determines how items will be produced in a traditional economy example: American Indian tribes plant corn when oak leaves grew to the size of a squirrel's ear. Timing is based on tradition.
-Economic activities are centered on traditional family and social units such as a tribe.
Example: the Intuits of Canada share equally the results of a hunt.
-Traditional economic systems still exist in North America,
Latin America, Aborigines in Australia.
2. Command Economics also called Planned Economics:
-Relies on government officials (called central planners) to answer the three basic economic questions.
-Individuals have no say in economic choices. The government has complete control over the factors of production.
-Command economies no longer exist but they were quite common in the past.
Example: Old Kingdom in Egypt: The pharaoh ruled the economy and the government: he owned the land, controlled all trade, collected taxes……etc.
Another example: Western Europe during middle Ages.
3. Market Economies:
-Individuals answer the 3 basic economic questions i.e. the government has no say.
-The factors of production are owned by individuals. People can buy, sell and produce anything they want.
-The free exchange of goods and services is referred to as the market which provides the only form of control over what goods or services are bought and sold.
Example: U.S., Germany, Japan.
Self-Interest:
-Adam Smith, a Scottish economist author of "An Inquiry into the Nature and Causes of the Wealth of Nations" - believed that when the government is not involved in the economy, the market is driven purely by self-interest. Though some people believe that self-interest leads individuals to ignore the needs of others, Smith argued that self-interest benefits all the society by helping the economy grow.
How can self-interest benefit others?
Why would a newspaper carrier accept this job?
a) He believes that everyone deserves a newspaper.
b) It is good newspaper, more people should read it.
c) He is paid to deliver the newspaper.
Probably your answer is (C). The newspaper carrier is paid to do so.
The newspaper carrier's self-interest benefits other members of the society.
Incentives:
-An incentive is something that encourages people to behave in a particular way.
-The newspaper carrier gets a financial reward for every 50 new subscriptions. If the carrier doesn't sell t least 10 subscriptions per month, two dollars are deduced from his paycheck.
-The penalty like the bonus, acts as an incentive.
4. Mixed economies:
-It combines the elements of traditional, market, and command economic models to answer the 3 basic economic questions.
The 3 main categories of mixed economies are:
-Authoritarian socialism.
-Capitalism.
-Democratic socialism.
Authoritarian Socialism:
-Mixed economies that are closest to pure command model are said to practice socialism, also know as communism, in which the government owns nearly all the factors of production.
-Example: Government officials in Cuba develop long-term plans outlining how the nation's resources will be used. Such as long-range planning limits the decision making power of individuals.
Capitalism:
-Economies closest to the command model practice authoritarian socialism.
-Economies closest to market model practice capitalism.
-In the economy based on capitalism:
Individuals own the factors of production and answer the 3 basic economic questions.
Example: U.S., Canada, Japan.
-Government role in a capitalist society is limited. Taxation enables the government to provide a variety of services: education, social welfare, national defense.
-Private owner-ship and free choice is the basis of capitalism.
Democratic Socialism:
-The third type of nixed economy falls between authoritarian, socialism and capitalism.
-In this type of economy, the government owns key industries: electrical utilities, telephone networks which are of national concern.
-Individuals influence economic planning through elections.
Example: many European nations --> France, Sweden.
Answer the following questions:
1-Identify and explain the following terms:
- Traditional economy: An economic system based on society's values (its customs and tradition) to answer the three basic economic questions.
- Command economy: An economic system which relies on government officials (called central planners) to answer the three basic economic questions.
- Market economy: An economic system which in which individuals answer the 3 basic economic questions i.e. the government has no say.
- Mixed economy: An economic system which combines the elements of traditional, market, and command economic models to answer the 3 basic economic questions.
- Self-Interest: Individual freedom in choosing what to do, buy, sell or produce.
- Authoritarian: An economic practice in which the government owns nearly all the factors of production.
- Capitalism: An economic practice in which individuals owns nearly all the factors of production and answer the 3 basic economic questions with limited government involvement.
- Incentive: Something that encourages people to behave in a particular way.
- Democratic Socialism: An economic practice in which government owns key industries: electrical utilities, telephone networks which are of national concern.
2- Compare in a chart form between (Traditional, Command, Mixed and Market economies):
Points of Comparison:
1. Factors of Production.
2. The answers to the 3 economic questions.
3. Individuals.
4. An Example.
__________________________________________________________________________
Section 2: Features of the U.S. Economy
The United States has a capitalist economy and leans towards the market model which is driven by the individuals who are free to exchange their goods and services, seek jobs of their own choosing, and use their resources as they wish, and own and operate businesses.
Individuals have great number of economic freedoms. Because of these freedoms the capitalist economy is sometimes called "Free Enterprise System".
Free Enterprise:
A system under which business can be conducted freely with little government intervention. The U.S. free-enterprise system includes benefits to individuals as investment opportunities and prices that respond to competition.
Free Enterprise in the United States is based on five main features:
*Own private property and enter into contracts.
*Make individual choices.
*Engage in economic competition.
*Make decisions based on self-interest.
*Participate in the economy with limited government involvement and regulation.
Private Property and Contracts:
-Goods that are owned by individuals and businesses rather than the government are considered private property.
-Private property includes: clothes, CDs, books.
-For businesses: a factory, office building, and machinery.
Individuals and business owners can use their property or dispose it as they wish (buy, sell).
-Buying and selling goods and services is made by contracts which can be oral or written, but regardless of the form it's legally binding.
Individual Choice:
-Property owners, laborers, producers, consumers in the U.S.A. enjoy freedom of choice.
-Property owners are free to use or dispose their property as they choose within the laws set by the government.
*Laborers are free to pursue job opportunities.
*Producers are free to make whatever goods and services they wish.
*Consumers are free to buy those goods and services that best meet their needs and wants.
Example: If Mr. X owns several acres of undeveloped land. He is free to choose to:
*live on the land himself.
*give the land to the city for use as a park.
*leave the land undeveloped.
-If the land is sold to a development company, a series of other economic choices: shopping center, school ….etc.
Competition:
In business, a state of rivalry among sellers of similar products, in which each seller tries to gain a larger share of the market and increase profits.
Competition encourages producers to improve existing products and develop new ones to attract consumers.
Example: buying a portable CD: The high level of competition allows the consumer to find a portable CD with the features he/she wants in a price she is willing to pay.
Self-Interested Decisions:
Adam Smith: self-interest directs the actions of individuals and firms . In the U.S. free enterprise allows producers, consumers to make choices for their benefit.
-The unconditional and mutually beneficial transfer of products between producers and consumers is called "voluntary exchange".
Limited Government Involvement:
As the U.S. has a market economy, most production decisions are made by individuals or businesses not by the government. However, the government plays an important role:
*Establishing health and safety rules.
*Monitoring banking procedures.
*Prohibiting discrimination in the workplace.
Providing public services through funds rose through taxation on goods and services.
Economic Actors in Free Enterprise:
1- Producers: provide goods and services in the market to satisfy the needs and wants of consumers. They also develop new products and production methods.
2- Consumers: purchase goods and services provided by producers. The levels of product sales indicate if a producer has accurately answered the three basic economic questions of what, how, and for whom to produce.
3- Government: although producers and consumers provide answers to the three basic economic questions in the free-enterprise system in the U.S. still the government regulates the effects of these decisions on the economy as a whole.
Government, producers and consumers play different but connected roles in the market system.
Circular Flow Model:
In a free-enterprise system, resources, products, and money payments are exchanged among the different actors of the society (producers, consumers, and government). This exchange can be traced in a circular flow model.
Markets:
Product market: the Market in which producers offer and consumers purchase final goods and services.
Resource Market: the market in which individuals exchange resources (factors of production: natural, human and capital) with businesses and the government.
Income:
1- Money payments that individuals receive from business firms and government in exchange for resources.
2- Funds that a business takes in for supplying goods or services.
Flows:
Two Types of flows:
a- The flow of resources and products
b- The flow of payments
Circular Flow of Goods and Services:
Product Market:
Business:
Develop products for sale to household, government.
Government and Household (Individuals)
Gets products and pay business (product market)
Resource Market:
*Individuals own the factors of production (natural, human and capital resources)
*Business firms and the government: are the users of resources.
Answer the following questions:
1. Identify and explain the following terms:
- Free-enterprise: A system under which business can be conducted freely with little government intervention.
- Private property: Goods that are owned by individuals and businesses rather than the government.
- Contracts: Buying and selling goods and services is made by contracts which can be oral or written, but regardless of the form it's legally binding.
- Competition: In business, a state of rivalry among sellers of similar products, in which each seller tries to gain a larger share of the market and increase profits, is called the competition.
- Voluntary exchange: The unconditional and mutually beneficial transfer of products between producers and consumers.
- Product market: the Market in which producers offer and consumers purchase final goods and services.
- Resource market: the market in which individuals exchange resources (factors of production: natural, human and capital) with businesses and the government.
- Income: Money payments that individuals receive from business firms and government in exchange for resources or, funds that a business takes in for supplying goods or services.
2. What are the benefits to producers and consumers of the U.S. free-enterprise system?
To Producers: Producers are free to decide what to produce depending on their self interest with limited government involvement in their business.
To Consumers: Consumers enjoy the investment opportunities and prices that respond to competition between businesses in addition to the variety of products which help them find the most suitable for them.
___________________________________________________________________________________
Section 3: The U.S. Economy at Work
U.S. Economic Goals:
These goals are economic: freedom, efficiency, equity, security, stability, stability, growth.
1- Economic Freedom:
Maintaining freedom of choice in the marketplace is the heart of economic freedom.
Consumers: free to decide how to spend their incomes on goods and services.
Workers: free to seek a job of their choosing.
Savers and Investors: free to decide when, where and how to save or invest their money.
Business people: free to open new businesses, change from one business to another or close
existing ones.
2- Economic Efficiency:
*Efficiency has to do with the efforts to make the best use of scarce resources.
*Efficiency can be measured by how many goods and services a nation's workers produce.
*The more products each worker produces, the more efficient the economy will be.
3- Economic Equity (economic justice):
*It deals with questions of fairness and of right and wrong which are hard to identify.
*Policymakers often face problems to arrive at a fair decision.
*In the U.S. policymakers try to ensure that members of the society share the costs and benefits of the free-enterprise system as equally as possible.
4- Economic Security:
It refers to the nation's efforts to protect its members from: poverty, bank failures, medical emergencies and other situations that would harm the economic well being of individuals and the nation as a whole. Ex. (Insuring bank deposits - Giving economic assistance to troubled businesses)
5- Economic Stability:
*Economic stability involves 2 concerns:
-Achieving full employment; which is the lowest possible level of unemployment in the economy.
-Achieving stable prices; this is achieved when the overall price of goods and services available in the economy is relatively constant.
6- Economic Growth:
It has to do with efforts to increase the amount of goods and services produced by each worker in the economy.
Standard of Living: refers to the people's economic well-being. Economists measure a nation's standard of living by how much the average person is able to consume in a period of one year.
Economic Goals and Trade-offs:
Making one monetary choice over another is a basic problem in economics, at various times the people's needs and wants may conflict.
Although different nations may share a number of economic goals, those nations will prioritize those goals differently.
Priorities must be assigned:
-Nations decide which goals are most important.
Example: during World War II, national defense and security became high priorities so factors of production were shifted from business and industry to war effort.
Priorities can change:
-Policymakers decide which goals are most important according to particular needs and wants.
Example: during the 1970's in the U.S. dramatic price increases encouraged many people to focus on economic stability, whereas during the 1980's concerns about unemployment and low productivity encouraged policymakers to focus on economic stability and economic growth.
Priorities Can Conflict:
Conflicts among goals arise because different groups in the nation have different needs. Low-income workers or the elderly are more concerned with economic security than other economic goals. Businessmen, on the other hand, want to emphasize economic growth and efficiency.
Solutions Can Conflict:
Even if groups in the society agree on priorities, they may have conflicting ideas about the best means to achieve selected goals.
Policymakers may agree that the most important goal is economic growth so:
One group believes to raise taxes and use the money to help new businesses group.
The other group believes that lowering taxes allows businesses and individuals to buy more goods which stimulate growth.
Answer the following questions:
1. Identify and explain the following terms:
- Full-Employment: the lowest possible level of unemployment in the economy.
- Price of stability: this is achieved when the overall price of goods and services available in the economy is relatively constant.
- Standard of living: refers to the people's economic well-being.
2. Discuss how economic priorities and solutions conflict?
Priorities can conflict:
Priorities conflict because different groups in the nation have different needs. Low-income people are more concerned with economic security. On the other hand, High-income people want to emphasize economic growth and efficiency.
Solutions can conflict:
Different groups may have conflicting ideas about the best means to achieve selected goals.
Example:
Policymakers may agree that the most important goal is economic growth so:
-One group believes to raise taxes and use the money to help new businesses group.
-The other group believes that lowering taxes allows businesses and individuals to buy more goods which stimulate growth.
