Economic Systems

How the Government influences

how I make money

What are Goods?

What are Services?

What are Resources?

What is Scarcity?

Economic Systems

• Def. The method used by a society to produce and distribute goods and services.

• Or, How the government tells us what we can get and how to get it!

All Economic Systems Must Consider the Following Questions

1. What goods and services to produce?

 2. How will they produce them?

3. Who will get them?

4. How much will they produce now, and how much later?

Each economic system answers these questions in a DIFFERENT WAY

Types of Economic Systems

There are 3 basic types of economic systems

1. Traditional Economy

• Economic questions are answered by habits and customs (the way it has always been done)

• Children work the same jobs parents worked, often farming or hunter/gatherer

• Fear Change!

• Ex. Eskimos, the Amish, Pigmies, Bush People

2. Command Economy

• The government answers the basic economic questions

• Advantages: able to act quickly in emergencies, provide for all people equally

• Disadvantages: Inefficient, no incentive to work hard or be creative

• Ex. Communist Countries (China, North Korea, former Soviet Union, Cuba)

3. Free Market Economy

• Economic questions are answered by individual buyers and sellers.

• Supply and demand influence economy

• People act out of self interest; motive for profit (money) drives the economy

• Also known as FREE ENTERPRISE or CAPITALISM

• Ex. The Philippines, United States, Western Europe, Japan

Mixed Economy: No economy is pure market, pure command or pure traditional, elements of each
appear in all economies, some have more elements of one economy than another

Philippine Mixed Economy

• While the Philippines is mostly a free market economy, it does have elements of a command
economy.
Features of Philippine Free Market Economy

1. Economic Freedom: individuals have the right to choose

2. Competition: more than one producer of good/services insures choice
3. Private Property: individuals have the right to own their own property, including business
4. Self-Interest: individuals make decisions based on what is best for them
5. Voluntary Exchange: individuals may freely buy and sell goods
6. Profit Motive: individuals are driven by a desire to profit (make money)

Features of Philippine Command Economy

1. Government regulation of some business practices

Ex. Wages, labor hours, safety practice.
2. Government limits certain choices

Ex. Cannot buy or produce certain goods/services

3. Government provides aid to the needy

Ex. Medicare, social welfare

My Pizzeria

My Pizzeria in a Free Market

• I answer the basic economic questions!

• I determine how much cheese and pepperoni goes on the pizza

• I determine the quality of the cheese and pepperoni

• I set my employees wages

• I set my business hours

My Pizzeria in a Command Economy

• The government answers the basic economic questions

• The government sets the amount of cheese and pepperoni on each pizza
 • The government determines quality of cheese and pepperoni

• The government sets employees wages

• The government sets business hours

Problem: What does the government know about pizza?

My Pizzeria in a Mixed Economy

• The Government and I both answer the basic economic questions

• I determine the amount of cheese and pepperoni on the pizzas; government determines the
quality of cheese and pizza

• I set employee wages; government sets minimum wage for employees

• I determine business hours; government determines whether I am safe to be open or not

Types of Government Intervention

1. Inform: or persuade consumers/providers/suppliers to act in a certain way.

 Publicize health risks (smoking)

 Disseminate information on disease patterns (swine flu), or risks of medical procedures

2. Regulation: determines how a private activity may be undertaken.

 At extreme gov’t can prohibit goods or activities.

 Setting standards for doctors and drug retailers
 Includes mandates: obliges someone to do something, and (usually, though not always) pay for
it.
 E.g. employers of a certain size must provide higher wages, protective gears for construction
industries
Regulation and mandates appeals to legislators

– b/c tackles problems without incurring government spending.

• Affects spending of those that are regulated e.g. two day hospital days after
delivery.

3. Finance: health care with public funds.

– Delivery can still be public.

4. Provide: or deliver health services using publicly-owned facilities and civil service staff.

– Usually publicly financed and provided

– More typical of developing countries

– Developed countries usually provide a lot of autonomy if publicly provided (GOCCs).

5. Taxes/subsides on goods e.g. cigarettes

– With diabetes increasing so quickly should certain foods be taxed more? (sugar content
of products)

Types of Goods

Public Goods: are goods that are commonly available to all people within a society or community

2 qualities:

– Nonrival: someone’s consumption does not reduce the amount available for others to
consume.

• Control of disease vectors

• Food and water safety

– Non-excludable consumer cannot be excluded from consuming the good either by

having to pay or through some other mechanisms.

– Classic example national defense

Non-rivalry: This means that when a good is consumed, it doesn’t reduce the amount available for
others.
– E.g. benefiting from a street light doesn’t reduce the light available for others but eating an apple
would.

Non-excludability: This occurs when it is not possible to provide a good without it being possible for
others to enjoy. For example, if you erect a dam to stop flooding – you protect everyone in the area
(whether they contributed to flooding defences or not.

A public good is often (though not always) under-provided in a free market because its characteristics of
non-rivalry and non-excludability mean there is an incentive not to pay. In a free market, firms may not
provide the good as they have difficulty charging people for their use.
Examples of Public Goods

National defence. If you protect the country from invasion, it benefits everyone in the country.

Street lighting. If you provide light at night, you can’t stop anyone consuming the good. Walking under a
street light doesn’t reduce the amount of light for others.

Police service. If you provide law and order, everyone in the community will benefit from improved
security and reduced crime.

Flood defences – Protecting the coastline against flooding provides benefits for the whole community.

The internet. Once websites are provided, everyone can see the website for free, without reducing the
amount available to others. (assuming an individual can access for free, which is not always the case)

Key points

A public good has two key characteristics: it is nonexcludable and nonrivalrous. These characteristics
make it difficult for market producers to sell the good to individual consumers.

Nonexcludable means that it is costly or impossible for one user to exclude others from using a good.

Nonrivalrous means that when one person uses a good, it does not prevent others from using it.

The definition of a public good

Economists have a strict definition of a public good, and it does not necessarily include all goods
financed through taxes. To understand the defining characteristics of a public good, first consider an
ordinary private good, like a piece of pizza. A piece of pizza can be bought and sold fairly easily because
it is a separate and identifiable item. However, public goods are not separate and identifiable in this
way.

Instead, public goods have two defining characteristics: they are nonexcludable and nonrivalrous. The
first characteristic, that a public good is nonexcludable, means that it is costly or impossible to exclude
someone from using the good. If Larry buys a private good like a piece of pizza, then he can exclude
others, like Lorna, from eating that pizza. However, if national defense is being provided, then it includes
everyone. Even if you strongly disagree with America’s defense policies or with the level of defense
spending, the national defense still protects you. You cannot choose to be unprotected, and national
defense cannot protect everyone else and exclude you.

The second main characteristic of a public good—that it is nonrivalrous—means that when one person
uses the public good, another can also use it. With a private good like pizza, if Max is eating the pizza,
then Michelle cannot also eat it it—the two people are rivals in consumption. With a public good like
national defense, Max’s consumption of national defense does not reduce the amount left for Michelle,
so they are nonrivalrous in this area.

A number of government services are examples of public goods. For instance, it would not be easy to
provide fire and police service so that some people in a neighborhood would be protected from the
burning and burglary of their property, while others would not be protected at all. Protecting some
necessarily means protecting others, too.
Positive externalities and public goods are closely related concepts. Public goods have positive
externalities, like police protection or public health funding. Not all goods and services with positive
externalities, however, are public goods. Investments in education have huge positive spillovers but can
be provided by a private company. Private companies can invest in new inventions such as the Apple
iPad and reap profits that may not capture all of the social benefits.

Can markets produce public goods?

Government spending and taxes are one way to provide public goods, but they're not the only way. In
some cases, markets can produce public goods.

Think about radio, for example. It is nonexcludable since once the radio signal is broadcast, it would be
very difficult to stop someone from receiving it. It is also nonrivalrous since one person listening to the
signal does not prevent others from listening as well. Because of these features, it is practically
impossible to charge listeners directly for listening to conventional radio broadcasts.

Radio has found a way to collect revenue by selling advertising, which is an indirect way of charging
listeners by taking up some of their time. Ultimately, consumers who purchase the goods advertised are
also paying for the radio service since the cost of advertising is built into the product cost. In a more
recent development, satellite radio companies, such as SirusXM, charge a regular subscription fee for
streaming music without commercials. In this case, however, the product is excludable—only those who
pay for the subscription will receive the broadcast—and thus is not a public good.

Some public goods also have a mixture of public provision at no charge along with fees for some
purposes. A public city park that is free to use but charges a government fee for parking your car, for
reserving certain picnic grounds, and for food sold at a refreshment stand would be an example of this.

Summary

A public good has two key characteristics: it is nonexcludable and nonrivalrous. These characteristics
make it difficult for market producers to sell the good to individual consumers.

Nonexcludable means that it is costly or impossible for one user to exclude others from using a good.

Nonrivalrous means that when one person uses a good, it does not prevent others from using it.

Merit Goods: goods that are thought to be good for someone regardless of the person’s own
preferences.

– Compulsory education.

– Wearing seat belts or helmets on motor cycles.

– Tobacco and drugs

The Roles of Government and Business

• For effective management, government’s role as a stakeholder must be understood.

• If the role of business were simply production and distribution of goods and services, business
would need little regulation.
 • But other goals exist – safe working environment, equal employment opportunities, fair pay,
clean air, safe products – which business does not automatically factor into the business
decision making process.

• As a result, it falls to government to ensure those goals are achieved.

A Clash of Ethical Systems

Interaction of Business, Government, and the Public

Government-Business relationship -

• Government influences business through regulation, taxation, and more.

• Business influences government by lobbying, and more

Public-Government relationship -

• Public influences government through voting and forming special interest groups.

• Government influences the public with politicking, public policy formation, and other
political influences

Business-Public relationship -

• Business influences the public through advertising, public relations, and other forms of
communication

• The public influences business through the marketplace, or by forming special interest
groups.
 Interaction Among Business, Government, and the Public
Lobbying

Regulations and Other

Forms of Persuasion
Business Government

Political
Interest groups Advertising Process Politicking
Not buying products Voting Politicalinfl
Public
Protests
Relations Interest
Groups
Contribution
Public s

Government’s Nonregulatory Influence on Business

Two major nonregulatory issues -

• Industrial policy -

• Concerned with the role of government in a national economy.

• Privatization -

• Whether current public functions (e.g., public education, public transit, social security,
fire service) should be turned over to the private (business) sector?

Industrial Policy

Industrial policy -

• Every form of state intervention that affects industry as a distinct part of the economy.
 • A current trend toward stronger industrial policy is likely to continue while the world economy
works to recover from the global financial crisis.

Privatization -

• The process of changing a public organization to private control or ownership.

• The intent is to capture the discipline of the free market and a spirit of entrepreneurial risk-
taking.

• Two functions a government might perform:

• Producing a service

• Providing a service

The Privatization Debate

Pro-Privatization -

• Government has no comparative advantage in many functions.

• Government is less efficient and less flexible.

Anti-Privatization -

• Some activities cannot be effectively handled by the private sector.

• Privatization produces uneven results in efficiency gains and cost savings.

• Privatization works best when the pursuit of profits does not work against broader social goals
or public policy.

Other Nonregulatory Government Influences

Government is:

• A major employer

• A standard setter

• One of the largest purchasers

Government influences business by:

• The use of Subsidies

• Transfer payments

• Loans and loan guarantees

• Taxation

• Monetary policy