Economic Systems

Chapter 2
Types of Economic Systems
• Economic system:
▫ how society uses resources to satisfy people’s
wants

• Three basic systems:

▫ Traditional
▫ Command
▫ market economies
Types of Economic Systems
Traditional Economy
• Individual roles and
choices are defined by
the customs of elders
and ancestors
• These economies are
usually based in
societies of
hunter/gatherers
• Sharing is a big part of
these economies
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 this system
 low productivity results in low standard of living
Examples of
Traditional economies
• Australian aborigines
The Mbuti in Central Africa
The Inuit of Northern Canada
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
WATCH THIS VIDEO (COMMUNISM)
 Types of Economic Systems cont.
Market Economy
• Government is not involved in
the economic decision
▫ 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
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
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
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