Week 2 - Economic Systems
Define economic system
An economic system is the method used by a society to produce and distribute goods and services.
Define capitalism
Capitalism is an economic system providing free choice and individual incentives for workers, investors, consumers and business enterprises. The means of production and distribution are not controlled by the government. (Free market economy, Free Enterprise system)
Explain the differences between a command, market and mixed economic systems with regard to profit motive, private ownership, consumer sovereignty, competition and government regulation, see chart below.
Command economic system: In a command economic system the profit motive has little opportunity to pursue individual rewards since all economic decisions are made by a central planner. Small businesses, if allowed, will return a large percentage of profits to the central government; the private ownership property rights, if any, are insecure since central planners make all economic decisions and property seizures are common if the central planner thinks the property should be used in another capacity; the consumer sovereignty, individual consumers have little say in businesses or government procedures offered as goods and services; the government is the producer of most goods and services, there is little or no competition among individual firms; government regulation is made by the government or central planner and makes almost all decisions about the production of goods and services in the economy. Market economic system: In a market economic system the private ownership has property rights that are strong. Individuals and firms own all the factors of production and if the government exists, the main role is to apply the rule of law governing property rights to all property disputes in a fair and equal way; the profit motive incentivizes individuals to start new businesses and make their businesses efficient. Firms owners will be able to keep most or all of their businesses profits; consumer sovereignty firms produce only the goods and services they think consumers are willing and able to buy. Products that do not sell will be discontinued and firms will increase the quantity supplied of products that are popular with consumers; in a market economic system there are high levels of competition because firms can freely open and close businesses; in a market economic system government regulation is minimal. If regulations exist, the focus is on protecting property rights, ensuring high levels of competition, and protecting consumers from harm. Mixed economic system: In a mixed economic system private ownership for individuals and firms can have their own property and the rule of law decides property distributes. Government can also own property to provide public goods and services. Government will sometimes seize property and pay the owner fair market value if the property in questions is to be used for an essential public good or service; In a mixed economic system, profit motive entrepreneurs can freely start businesses, but will usually be required to pay a certain percentage of their profits in taxes to the government; In a mixed economic system consumer sovereignty the businesses will usually produce what consumers want to buy. However, the government may recognize that certain public goods and services will not be produced in great enough quantities by the private market and will produce the product as a public good service; In a mixed economic system high levels of competition are encouraged, but the government may allow certain monopolies to exist if there is a compelling reason to have one producer of the goods or services; In a mixed economic system there may be government regulations for example the government may require licenses and government paperwork to start the business. Businesses may have to follow government labor, consumer safety, and environmental laws.
Define communism
Communism is an economic and political system in which all means of production are owned in common by authoritarian government rather than by individuals or private enterprise. Examples include China, North Korea, Cuba and the former Soviet Union. This system was created by Karl Marx.
*Define "division of labor" and "specialize" and identify the benefits of both as they relate to markets and economics.
Division of Labor and Specialization is the basis for an economy to exist. Three benefits are: doing it better, no time required to switch tasks, and creating more effective ways to do the task. Division of Labor refers to the practice of dividing the work to make something into separate tasks. Specialization is the basis of trade and interdependence among individuals, businesses, cities, regions and countries. Workers become specialized in different tasks. We earn a living by doing tasks, taking our wages to purchase goods and services from other workers. Specialization is can be observed when individuals or businesses concentrate on a single activity or an area of expertise when producing a good or service. In economics, specialization is important because it boosts the overall productivity of a business or country. For example, a firm might use specialization by creating division of labor in the production of a good or service. An example of division of labor at a fast food restaurant might be when one employee takes drive-thru orders while another employee makes the food. Both employees get better at their tasks through repetition and can do the task more quickly with fewer errors. The fast food restaurant which has chosen to specialize in convenient, ready-made meals would probably not try to offer gourmet, fine dining at the same time and lets other restaurants specialize in this type of cuisine. Specialization leads to.....
Explain how the command, market and mixed economic systems meet the broad social and economic goals of freedom, security, equity, growth, efficiency and price stability, full employment, and sustainability.
ECONOMIC FREEDOM refers to the ability of consumers, producers, and workers to make their own decisions about consumption, production, and distribution of goods and services. The more individuals and businesses make these decisions, the more economic freedom exists in the economy. Market economies tend to have a great deal of economic freedom while command economies may limit economic freedom in favor of more equal distribution of wealth. ECONOMIC SECURITY has to do with protecting individuals and businesses from risk. In a market economy, individual workers and business owners are usually responsible for themselves during challenging economic circumstances. They protect themselves through insurance available in the private market or by saving money for the future. In command economies, the government provides security through government insurance programs, guaranteed jobs, and housing/food allowances. ECONOMIC EQUITY refers to fairness within the economy. There is a lot of debate in public policy about what is fair. Some people define fairness as equal access to jobs, goods, and services. Others define fairness based on outcomes. For example, if someone works hard to start a successful business, many believe that it is "fair" for that individual to keep the profit from that business. Market economies pursue this goal by ensuring competitive markets and protecting property rights. Command economies pursue this goal by redistributing wealth and ensuring everyone's access to public goods. ECONOMIC GROWTH is increasing production of goods and services over time. This occurs through increases in factors of production or new technological innovations. Most countries measure growth through calculating the percentage change in real GDP from one period to the next. Real GDP is the total value of all final goods and services produced within a nation in a given time period adjusted for inflation. Although both command and market economies are capable of growth, command economies are capable of growing rapidly, using within targeted sectors, when guided by a central planner. Market economies may grow more slowly, but growth tends to be more sustainable through the organic forces of supply and demand within markets instead of arbitrary targets. ECONOMIC EFFICIENCY when factors of production are allocated to their most productive use. The most efficient economies have fully employed resources, specialize in goods and services for which they have the lowest opportunity cost, and have high levels of competition in the market. Market economies tend to be very efficient due to competition and free trade. Supply and demand allows price to ration factors of production, goods, and services and allocate them to the most efficient uses. Command economies may be less efficient since there is no competition if government owns all the productive resources, everyone has to have a job, and no profit motive drives the people to reduce the costs of production. PRICE STABILITY refers to an economy making sure that increases in the overall price level of goods and services in the economy is predictable and protects the purchasing power of money in the economy over time. In the U.S. economy, the Federal Reserve system uses monetary policy, tools to increase or decrease the quantity of money in circulation, to target a predictable inflation rate of 2%. In market economies, price levels can fluctuate with increases and decreases in the business cycle, rising significantly in expansionary times and falling drastically in times of financial crisis. Command economies are more likely to have central authorities who take action against rising or falling price levels through fiscal or monetary policy. FULL EMPLOYMENT seeks to ensure that all those who are willing and able to work have the opportunity to do so. In the U.S., full employment is typically an unemployment rate between 4% and 6% depending on economic conditions. The unemployment rate is never zero because of people moving from one job to another or people graduating from an educational program and looking for a job. Market economies can achieve full employment during strong expansions, but will often suffer high levels of unemployment during contractions. Command economies will try to ensure full employment, but will often employ resources in less efficient uses and pay income much lower than that found in a market economy. ECONOMIC SUSTAINABILITY usually refers to the goal of individual countries to maintain an upward trend of real Gross Domestic Product growth in the long-run. For highly developed countries, the goal for long-run real GDP growth trend desired may be 2-3% while it may be much higher for developing countries. To achieve these targets, countries must make decisions and create conditions benefiting the economy for the long term as well as the short term. There are many viewpoints about sustainability, but some of the considerations in building a sustainable economy could include food systems, environmental protection, new business creation, technological development, and the health of the overall financial system. In market economies, sustainability is a goal if firms believe it is in the firm's self-interest to pursue sustainability. In command economies, the government or central planner will determine the type of sustainability to pursue.
Provide examples of how individuals and businesses specialize.
Examples of how individuals and businesses specialize. We don't make all of our electronic devices, countries do not make all of the goods and services they need. Wisconsin = dairy Florida = oranges.
Explain the role of government in a circular flow model of a mixed economy.
In a mixed economy, the government spends and collects money, buys and sells goods and services.
Explain the roles of households, businesses, the factor market and the product market found in a circular flow model of a market economy.
In the circular flow model of a market economy the households typically own the factors of production (the factor market) and are the consumers of goods and services. Businesses or firms use resources to produce goods and services (the product market). Firms purchase resources from the factor market, supplied by households, to create goods and services. Households purchase and goods and services from the product market. Goods and services flow in one direction (physical flow), while money flows in the other direction (monetary flow).
Define socialism
Socialism is an economic and political system in which the means of production and distribution of goods and services are controlled substantially by the government, as the result of elections, rather than controlled by private enterprise. Norway and Sweden are examples of socialist states.
Identify and explain the three basic economic questions.
The 3 basic economic questions a society must answer are: What goods and services are to be produced? How should these goods and services be produced? Who consumes these goods and services? What? military or civilian goods, How? Assembly line, robots or workers, Whom? Goods are allocated to each segment of society, who gets what? Who gets the big house or does everyone get the same size house?
Explain how a traditional, command, market and mixed economic systems answer the three basic economic questions. (Chart - Teachers Notes, pg 17)
Traditional economy - relies on habit, custom or tradition to answer three basic questions. The traditional economy will produce the goods and services it has produced for generations based on what the ancestors produced. The economy will pass the same production methods used in the past from generation to generation. Goods and services are distributed using the methods used by past generations. Command economy - A system where the government, rather than the free market, determines what goods should be produced, how much should be produced and the price at which the goods will be offered for sale. The command or planned economy is a key feature of any communist society. China, Cuba, North Korea and the former Soviet Union are examples of countries that have command economies. The command economy will produce what the government or central planner says it will produce. The economy will produce using whatever methods the government or central planner says it will use. The economy will distribute the goods and services to whomever the government or central planner says should get it. Market economy - An economic system in which economic decisions and the pricing of goods and services are guided solely by the interactions of a country's citizens and businesses and there is little or no government intervention or central planning. In a market economy, firms or businesses will produce what they believe consumers will want to buy. Firms will produce goods and services using methods they believe will result in selling goods and services for the most profit. Individuals and firms in the society who are willing and able to pay the price of the good or service will obtain it. Mixed economy - modern economies mix a market economy with varying degrees of government influence. In a mixed economy, many firms will produce what they believe consumers will want to buy, but government may restrict the production of certain goods or produce public goods. Firms will try to produce goods and services using methods they believe will result in selling goods and services for the most profit, but the government may tax firm profits or mandate production processes. Individuals and firms in the society who are willing and able to pay the price of the good or service will usually obtain it, but the government may restrict some people from accessing certain goods
