Economics and Economic

Systems
PSCI 101

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Learning Objectives

Compare Compare Understand Evaluate

Compare Compare Understand the Evaluate

capitalism, market based basics of a arguments for
socialism, and centrally market-driven and against
communism planned economy government
and fascism economies intervention in
the eocnomy

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 Capitalism

•Private ownership
•Consumers and businesses make decisions

Political- •Income and wealth unequal

Socialism

Economic •Government ownership

•State makes decisions (there may be elections for the
decision-maker)

Systems •More equality but less efficiency

Communism

•Government ownership
•One-party state makes decisions
•Often less efficient but could be more equal

Fascism

•“Some are more equal than others”

•Inefficient and unequal

There is a lot of information about each of these forms of economic system above and in
the book, but I’ll make a few points here to elaborate.

The main textbook (understanding political ideas and movements) really only discusses
Marxism, which is the philosophy that lead to the creation of communist political economic
systems and Fascism, which is a system where has no specific economic theory beyond
serving the interests of the state. In these chapters, it also discusses anarchism, which you
can read for review if you want but it is not required (has a lot of discussion of human
nature ,the state, freedom, equality, etc.). You will need to read the sections from the
usually optional textbook (an introduction to politics).

You may have heard the phrase “some are more equal than others” before. This is a
paraphrase of a famous quotation from the book Animal Farm. In fascism, and to an extent
in communism, what often determines who gets what is not the market or the plan (to be
explained in more detail momentarily), but who is loyal to the state. Even if everyone is
supposed to be “equal,” high level party officials will often have better economic standing.

A second point is about inequality. Inequality can be bad – for example, in a country where
most people live in poverty and there are few wealthy people with power. However, what if
those at the bottom of the income distribution are doing fine, with those at the top just

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being super well-off? The US has very wealthy individuals like Jeff Bezos (Amazon), but even
people with far less wealth than he has (Dr. Kaufman) enjoy a very good standard of living,
especially compared to others in the world. Is that a bad thing? It is up to you to decide.

Finally, I will say that most economies are actually a mixture between pure capitalism and
socialism rather than being the “textbook definition” forms of either. We generally refer to
these as mixed economies. Countries like the US lean more towards the free-market, and
social-democratic countries like Sweden lean more towards socialism.

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 Markets vs.
Planning

 Markets determine prices and

quantity through supply and
demand
 Centrally planned systems
determine quantity through
decisions made by the state
 Each has pros and cons, and
in practice, no system is purely
one of these

Markets can be very efficient and innovative. People have a profit motive, so they want to
minimize costs and come up with the best ideas on how to do things in a cost-effective
way. They tend to allocate goods and services very well. The law of supply and demand
says that as price increase, producers will want to sell more, and consumers will want to
buy less (and the inverse). This can fail, however – what if you see everyone is going out to
eat at restaurants all of the time and paying top dollar, so you open a restaurant – and then
there is a pandemic. Suddenly, demand has fallen, and you have an oversupply! There may
not be much provision for basic human needs if these are not profitable, leaving the
poorest to be very vulnerable.

Central planning tends to be very inefficient and not great at allocating resources. How do
you determine what everyone in the country wants at all times?! This is why you will often
see shortages, especially of the types of somewhat unnecessary consumer goods that
people want, in these systems, with a focus on providing for basic human needs, like
education and health care, along with industrial production. These systems can be more
equal, but there is a risk that everyone will be equally poor and that consumers may be
unhappy with their options.

In practice, as I mentioned previously, most countries have a mixed economy. Certain

things are owned by the government (i.e. some utilities, public schools), and others are run

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by the individuals and businesses. Even “Communist” China has freed up many elements of
their economy, although the state still has a lot of control over it. They also have an
inequality level similar to the United States, so they did not actually manage to greatly
improve equality with their reduced economic freedom.

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 Pure competition?

MARKET POWER BARRIERS TO ENTRY

Market power is the ability to set prices. If a firm is very large and established, it may have
a lot of power to set whatever price it wants to and other smaller firms may become “price
takers.”

This could be because the product is special – people will pay more for something like an
iPhone than it is probably worth. It could also be because there are a small number of firms
– or really just one powerful firm – that are taking advantage of their position in the
market. Many other companies produce smartphones, and charge far lower prices, so
Apple has competition. But, what if you are one of the only firms? The one textbook book
talks about the situation before foreign cars were widely sold in the US. Only a few
companies sold cars, so there was very little competition. Today, there are few options for
cell-phone carriers – so even if you can buy a cheap smartphone, your bill will be going to
one of only a few companies. This is called a monopoly (one firm) or oligopoly (a few
firms).

How do we end up with just a few firms? Think back to the concept of “price takers.” A
large, established firm may be able to produce very efficiently, or purposefully take a loss
for awhile, to undercut prices. Other firms who cannot afford to offer that price in the long
run will fail, reducing the number of firms in the market. Once other firms are out, they can
overcharge. This is one reason that governments regulate monopolies.

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Another way this could happen without any purposeful price manipulation is barriers to
entry. What if there are few firms just because it is difficult to get started up? Maybe it is very
expensive to buy the land or equipment needed. Maybe it requires specific education or
training. This will reduce the people involved in the market and make it less efficient.

Finally, it might be best to have only one firm. For example, imagine the chaos if different
companies were building water and power lines across each city (though highly regulated
competition may still benefit consumers in terms of quality or price). Often the government
will own these industries or regulate which private companies can operate them.

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 Transaction Path
Other market costs dependency
imperfections
and failures Provision of
public and Inequality
social goods

Externalities

In addition to monopolies and oligopolies, there are other market imperfections and
failures.

Transaction costs are the costs of doing business. It is hard to have a “pure” market in part
because we can’t find all of the various buyers and sellers. The book mentions the example
of eBay. Before eBay, you had to settle with what local people would offer for items you
had for sale. Some people still do this because it wouldn’t be worth the time and effort to
take the photo, type up the listing, and go to the post office to sell the item. Plus, you have
to give eBay a cut.

Path dependency is the idea that once we get on a certain path, we might not want to stray
from it because there are high costs, even though another path may be more efficient in
the long-run. A good example is the “QWERTY” style keyboard. Imagine if we had to
replace every keyboard in the world and re-teach every adult to type!

Markets don’t want to provide things that don’t make money. Because of this, there may
not be enough of what we call public or social goods. Without government, who would
build roads or schools? Certainly, someone would – but they may not be available for
everyone to use without a high price.

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As previously mentioned, market systems tend to have inequality (this is in part due to the
lack of public goods). This is fine if you are Dr. Kaufman and you still enjoy a high standard of
living as in my previous example, but what about the people in our society who do live in
poverty? This may be in part due to personal choice, but is more likely in a market system.
Often, poverty is also associated with other societal issues, like crime or poor health, which
could affect others as well (this is an example of an externality).

What is an externality? This is something that affects people outside of the transaction in an
unintended way. For example, if a person who was in poverty turned to crime, their criminal
activity could affect other people in the neighborhood, as they might be worried about going
out to do business and becoming a victim, or their property values may fall as crime rises.
The typical example is pollution. Very few people create pollution intentionally, yet it is a
byproduct of much economic activity. Just driving your car or cooking your dinner creates
some pollution, though most is created through industrial processes and international
shipping. It mostly affects the people who live around the pollution by making their
environment unpleasant and unhealthy, rather than the producers of it. Externalities can also
be positive. For example, if I keep my own home nice, my neighbor’s property value may
increase without any action on their part.

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 To intervene or not intervene?

Why leave markets alone? Why intervene?

 Subsidizing poor decision-making
 Taxes, subsidies, and regulation reduce
efficiency
 Economic policies may benefit
government officials rather than society
 Market imperfections and failures
 Economic stability, security, and growth
 Intervention is not necessarily
“Communism”

A key argument for leaving markets alone is that the taxpayer should not bail out poor
decision-making. The book gives the example of someone who failed to save for
retirement. Should we reward them with a pension? Or let them suffer because they failed
to save? (It is worth noting that Social Security is for the most part a forced savings
program – you generally get money back in proportion to what you put in through working,
although there are also programs for people who ended up needing support through no
fault of their own, like surviving dependents of those who paid in, or people with
permanent disabilities).

Another is the trade off we discussed between equality and efficiency. Any intervention
into the free market by definition makes it less efficient. For example, consider that the
government subsidizes higher education by giving students access to grants and loans. They
may have academic provisions to keep getting them, but initially, there is no need to prove
you will be a “good” student. Wouldn’t higher education be more efficient if we weren’t
subsidizing the 50% of people who fail to graduate in the beginning? Side note: you may
now be starting to identify with the statement in the book about how people want
interventions that benefit themselves 

There is actually an entire school of economic thought (called public choice) that goes
further, and says these regulations are set up to benefit the policymakers. For example,

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they will put in place economic policies that benefit their re-election chances, rather than
what is best for society.

There are many reasons that most countries do intervene to a certain extent, however. First,
keep in mind all of the various market imperfections and failures we just learned about. Most
governments step in to try to address those.

Governments also help to keep their own legitimacy by ensuring there is a stable, secure,
and growing economic system. They want to make sure everyone who wants a job can find
one, that people feel confident in conducting business, and that the economy is growing.
This is why during difficult economic times like we have been having since covid began they
will step in more – increasing unemployment benefits, giving loans to businesses to keep
employees on staff, and sending out stimulus checks. Theoretically, this could pay off in the
long run, as they will make more taxes from a productive economy, more people will be
willing to do business, and it doesn’t hurt that generally the growth will boost their re-
election chances.

Finally, keep in mind that many people who wrote in defense of the free market saw the only
alternative as Communism. This was during an era where the United States and the Soviet
Union were powerful world rivals, and people were scared of moving to the other extreme.
In practice, most economies fall somewhere in between.

In your assignment, this is the question you will be weighing. Will you go with more market
control, more state control, or somewhere in between?