Chapter 2:

Economic Systems and

Decision Making

GOALS
1)Identify different economic systems
2)Evaluate Economic Performance
3)Define Capitalism and Describe Economic Freedom
 Three Basic Economic
Questions

 What to produce?
 Because of scarcity, each choice
to produce comes with an
opportunity cost.
 How to produce?
 How will a society use their
resources to make goods?
 For Whom to produce?
 Who consumes the products?
Are we making capital goods or
consumer goods?
Evaluating Economic
Performance

 General Economic goals translate

from nation to nation. There are
six goals.
 1) Economic Freedom- people
want to make their own decisions
about what to buy, what job to
have, whom to marry – this can
help build patriotism.
 2) Economic Efficiency- resources
must be used wisely so everyone
can get what they need and most of
what they want.
 Economic Goals of the US

 3) Economic Equity- discrimination

should not exist in the workplace, or in
products. People should get a “fair
share of the pie”
 4) Economic Security- people want
protection from adverse economic
events like recession and
unemployment – this is the concept of
a “safety net”.
Economic Goals of the US

 5) Economic Growth and

Employment -the economic
system should provide as many
jobs as possible and should
improve the standard of living.
 6) Price Stability- prices should
remain about the same with little
or no inflation- a rise in the
general level of prices, this
protects those on fixed incomes
 Types of Economic Systems

 Economy/economic system- an organized

way of providing for the wants and needs of
a people. There are four main types:
Traditional
Command
Market
Mixed
Continuum of Economies
 Traditional Economy

 Traditional
Economy- economic
activity stems from
formal, habit, or
custom, roles are
defined by customs of
elders
Ex. – tribal
communities
Traditional Economy

 Advantages (+)
 Community works
together to support the
entire group
 Everyone knows their
role and what to
produce
 Everyone knows how
to produce
 For Whom question is
answered by customs
and tradition
Traditional Economy

 Disadvantages (-)
 Discourages new ideas
and new ways of doing
things
 Those who act
differently than their
roles are punished –
gender roles are
clearly established
(men = hunters,
women = gatherers)
 Lack of change and
progress leads to low
standard of living
Command Economies

 Command/ “Centrally
Planned” economy - the
central (government)
makes the economic
decisions
 Government owns the land
and the capital (instead of
the households) and control
all aspects of labor.
 Ex: North Korea, Cuba,
former USSR, China is in
transition
Command (Centrally Planned)
Economies

 Centrally planned economies are associated with socialism and communist

governments.
 Socialism – social and political belief that wealth should be distributed evenly
through a democratic society.
 Communism – a system of government where all of the power and economic
decision making resides with the central government. Unlike socialists,
communists are authoritarian and believe that the government and not the people
should make decisions.
 Karl Marx & Friedrich Engels

 Introduced socialist beliefs to

the Soviet Union in The
Communist Manifesto.
 After a revolution in 1917, the
word communist changed to
the meaning we understand
today.
 Vladimir Lenin

 Led revolution in Soviet Union in 1917

 Introduced central planning in 1920s
which continued until the end of the
Cold War.
 Soviet planners wanted to build national
power and create the best community in
the world.
 Agriculture (collective farms)
 Industry (defense oriented)
 Consumers (low wages, hard to get access
to goods)
Command Economy (+)

 Advantages
 Economy can
change direction
drastically in a
short period of time
Health and public
services are
available to
everyone at little
or no cost
Command Economy (-)

 Disadvantages
 not designed to meet the wants
of consumers
 there is little incentive to
work hard (-) a large
decision making
bureaucracy is required
 inflexible for day to day
problems
 new ideas, changes,
inventions not encouraged
 Market Economies

 Market economies exist because no one

nation is entirely self-sufficient.
Markets allow us to exchange and
mutually benefit from trading.
 In a market economy:
 Households and firms act in their own
best interest to answer the What, How,
and For Whom questions.
 Consumers decisions (demand) act as
“votes” for products and helps to
regulate prices.
 Ex: US, Japan, Great Britain, France,
South Korea, Singapore
The Circular Flow Model
$ COSTS $ INCOMES
FACTOR
MARKET

RESOURCES INPUTS

BUSINESSES HOUSEHOLDS

GOODS & GOODS &

SERVICES SERVICES

PRODUCT
MARKET
$ REVENUE $ CONSUMPTION
 Adam Smith

 Observed that people responded

predictably to positive and negative
incentives.
 When competition is present, buyers and
sellers will work together to get prices and
quantities at a point where they agree
(equilibrium).
 Smith’s Invisible Hand Theory supports this –
self-interest and competition work together
to regulate the marketplace.
 Also called for restricting the role of
government in the economy – wanted to
enact lassiez-faire policy “let them do as they
please”
Market Economy (+)

Advantages
Countries can specialize in products that
they can make efficiently (comparative
advantage)
Adjusts well to change
High degree of individual freedom
Small amount of government interference
Decisions about what to produce are not
left in the hands of the few, made by many –
this is called consumer sovereignty
Large variety of goods and services
available
High degree of consumer satisfaction
Incentives drive competition
Market Economy (-)

 Disadvantages
 Does not provide for basic
needs of everyone in society
 Does not provide services
people don’t value highly
 Uncertainty faced by workers
due to change
 Can fail if:
 1- there is no competition
 2- resources are not mobile,
 3- consumers have
inadequate information
 Mixed Economies

 Many of the goals for the market

economies, like the US economy,
work against each other, it is
impossible to completely balance
all of them against each other.
 Even though many market
economies believe in “lassiez-
faire”-as society has changed it
has become necessary to involve
the government.
 Because of that, “mixed”
economies are seen around the
globe today.
 Mixed Economies

 Governments in market economies today have to create laws that protect

property and enforce contracts. That’s because of:
 Capitalism- system where private citizens own the factors of production
 Free enterprise- competition in business is allowed to flourish with minimum
government interference
 Voluntary Exchange- the act of buyers and sellers freely and willingly engaging in
market transactions, transactions are only made if the buyer and seller are better off
afterwards

 To ensure that our households and businesses are protected, the 5 th

Amendment grants private property protections (eminent domain), as well.
 Modified Free Enterprise

 Mixed economy or
modified free
enterprise economy-
people carry on their
economic affairs freely,
but are subject to some
government interjection
and regulation
The Role of the Entrepreneur

 Entrepreneurs
-organize and manage
land, labor, and capital
to make profits
 They are the driving
force between
economic growth
 Everyone benefits
when the entrepreneur
is successful
The Role of the Consumer

 Consumer
sovereignty- the
customer rules the
market
 Businesses will sell
what people want to
buy, at the prices
they are willing to
buy them for, if
enough of them
don’t like a product
it will not be sold
The Role of Government

 Protector- of
consumers,
employees, property
owner, etc.
 Provider and
Consumer- gives
things like national
defense, education,
welfare, parks, roads,
etc. also buys things
like any business
The Role of Government

 Regulator- preserves
competition in the
marketplace, monitors
various business and
industries
 Promoter of National
Goals- reflects the will
of the majority of the
people