Chapter 2: Economic Systems. 1. Answering three Economic Questions. 2. The Free Market 3. Centrally Planned Economics 4.

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1 1 Chapter 2: Economic Systems 1. Answering three Economic Questions? 2. The Free Market 3. Centrally Planned Economics 4. Mixed Economics 1. Answering three Economic Questions What goods and services should be produced? How should these goods and services be produced? Who consumes these goods and services?.... Because resources are scarce Economic System The structure of methods and principles a society uses to produce and distribute goods and services A way a society answers these questions defines its economic system Economic Goals and Societal Values Different societies answer the questions based on importance they attach to various economic goals Economic Goals 1. Efficiency-Societies try to maximize their resources 2. Freedom-the opportunity to make your own choices 3. Security- Safety net -programs that protect people who face unfavorable economic conditions 4. Equity-How should we divide the pie? 5. Growth-innovation plays a huge role in economic growth Traditional Economies An Economic system that relied on habit, custom, or ritual to decide the three economic questions. There is little room for innovation or change in traditional economies Led to more modern economic systems Three Economic Systems Dominates the modern world The free market economy (capitalism) The centrally planned economy (communism) (socialism) The mixed economy a little of both 2. The Free Market Economic Freedom-highly valued by American Society Markets-any arrangement that allows buyers and sellers to exchange things We are not producers of all our wants Why Markets Exist

2 2 Specialization-concentration of the productive efforts of individuals and businesses on a limited number of activities Buying and Selling-sell what we produce and buy what we want Free Market Economy An economic system in which decisions on the three key economic questions are based on voluntary exchange in markets Individuals make their own decisions Capitalism-the capital that entrepreneurs invest in businesses are vital Households and Firms Household-person or group of people living in a single residence Firm-business or an organization that uses resources to produce a product, which it then sells Factor and Product Markets Factor Market-the arena of exchange in which firms purchase the factors of productions from households Product Market-the arena of exchange in which households purchase goods and services from firms The Self-Regulating Nature of the Marketplace Self Interest-an individual s own personal gain Incentive-the hope of reward or fear of penalty that encourages a person to behave in a certain way Competition-the struggle among producers for the dollars of consumers The Invisible hand-adam Smith-the self regulating nature of the market place Advantages of the Free Market Efficiency-produce what consumers want Freedom-work where you want, produce what you want, consume what you want Growth-innovations Consumer Sovereignty- having the power to decide 3. Centrally Planned Economics How Central Planning Works Government makes all the decisions on three questions (command economy) Government owns all factors of production Direct contrast to free market structure Socialism and Communism Socialism range of economic and political systems based on belief that wealth should be distributed evenly throughout a society Communism-political system in which government owns all resources and means of production and makes all economic decisions Authoritarian Form of government that limits individual freedoms and requires strict obedience from its citizens

3 Communist governments are always authoritarian Two Communist Economies The Soviet Union-1917-Bolshevik Revolution-Joseph Stalin-broke up in 1991 China-1949 to late 1970 s-government planners controlled all aspects of Chinese society Disadvantages of Centrally Planned Economies Efficiency-no incentive to work hard Freedom-discourages competition Growth-no innovation no growth Equity-human intuition prohibits equity The need to satisfy all wants and needs 3 Chapter 2 Essential Question: How does a society decide who gets what goods & services? The three key economic questions, social values, markets, differences among economic systems, and the rise of mixed economies, key economic goals. If resources were unlimited, we could all have whatever we want. But as the scarcity-forcestradeoff principle reminds us, resources are limited. Just as scarcity forces individuals to make choices about what to have and what to give up, it also forces societies to make choices. The larger and more advanced a society is, the more numerous and complex these choices may be. In the end, however, these choices boil down to three basic questions. What to Produce, How, and for Whom? In deciding how to allocate limited resources, every society from a tribe of people living in the Kalahari Desert to a modern industrial nation like the United States must answer three fundamental economic questions. Each society answers these questions differently, depending on its priorities. The questions, however, are the same for everybody. You know that goods and services are produced by combining the factors of production: land, labor, and capital. But how is this done, exactly, and in what combination? Because of scarcity, no society can produce everything its people might want. This raises the question: What goods and services are most wanted and needed? For example, should the United States conserve wilderness areas for recreational purposes or open them up to logging or oil exploration? Should the U.S. steel industry produce more car parts or more beams for skyscrapers? What do consumers want or need more: sneakers or diapers? Teachers or dentists? Books or video games? With millions of possible products and many different interests competing for the same limited resources, the choices seem endless. The way a society answers the three economic questions will necessarily depend on its economic aspirations and social values. Most societies try to address some or all of the following 3 economic goals. A Society s Answers Depend on Its Economic Goals. Economic freedom. In our society, we place a high value on economic freedom the ability to make our own economic decisions without interference from the government. When you choose to buy something, whether it is a music download or a used car, you are exercising this freedom. When you choose to sell your car or go into

4 business selling cars or anything else, you are exercising this freedom. A society that values economic freedom gives individuals and businesses the right to make decisions about how to use their resources, without government intervention. 4 Economic efficiency. An efficient economy makes the most of society s resources. It delivers the goods, literally, by allocating resources in such a way that the greatest number of consumers get what they want with the least amount of waste. Because unemployed workers are a wasted resource, an efficient economy strives for full employment, which exists when all who want to work can find jobs. Economic equity. The term equity concerns fairness and justice. Economic equity involves the fair and just distribution of a society s wealth. A society that values economic equity seeks to give everyone his or her fair share of the economic pie. But what constitutes a fair share? Is it fair that corporate executives make millions while retail workers earn minimum wage? Is it fair that women, as a group, earn less than men? People often disagree on questions of equity, which makes it a difficult goal to achieve. Most societies consider these goals when making economic choices. But societies differ in the degree of importance they attach to each goal. Sometimes progress toward one goal can be achieved only at the expense of another. For example, when the government taxes our wages in order to pay unemployment benefits, it is contributing to society s economic security. But it is also encroaching on our economic freedom to control our own resources. Societies, like individuals, must weigh the tradeoffs and opportunity costs of pursuing any particular set of economic goals.

5 5 4 Mixed Economies Reasons for Government Involvement Laissez-faire-government generally should not intervene in the marketplace Private Property-property owned by individuals not the government Mixed economy-market-based economics in which government is involved to some extent Government in Market Factor Market-government instead of individual owns factors of production Product Market-government purchases all goods and services and provides them the public Continuum of Mixed Economies The United States Economy Free enterprise economy-private or corporate ownership of capital goods Government of the U.S. plays a major role in the economy promote the general welfare Some people think that the government intervenes too much in the economy What do you think?

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