Chapter 2 Economic Systems and Economic Tools
Essential Question: How do various economic systems answer the 3 basic economic
2.1 Economic Questions and Economic Systems
A. The Three Economic Questions
1. What goods and services will be produced?
2. How will they be produced?
3. For whom will they be produced?
B. Pure Market Economy (or pure capitalism)
1. Private firms account for all production.
Any income derived goes to resource owners.
2. Adam Smith (1723-1790) argued that although each individual pursues his or
her self-interest, the “invisible hand” of market competition promotes the general
3. Market failures – what are some examples?
C. Pure Centrally Planned Economy (communism)
1. All resources are government-owned.
Production is coordinated by central plans of govt.
2. Central planning failures
D. Mixed Economy - combines central planning with competitive markets (every country
in the world has mixed economy) where are they on the economic scale?
E. Transitional Economy – process of shifting from central planning to competitive
markets, involves converting state owned enterprises to private enterprises
F. Traditional Economy – shaped largely by custom or religion
2.2 Production Possibilities Frontier
Essential Question: What causes the Production Possibilities Frontier (PPF-curve) to
A. PPF – if the economy uses its available resources and technology fully and efficiently
in producing consumer goods and capital goods, it will be on its PPF curve AF
1. movement along PPF = giving up some of one good to get more of the other
2. movement down curve = the opportunity cost of more capital goods is fewer
3. The shape of the PPF reflects the law of increasing opportunity cost
4. PPF may shift as a result of changes in resource availability or in technology
2.3 Comparative Advantage
A. Law of comparative advantage helps explain why even a person talented at many
things can get more done by specializing.
B. Specialization – occurs when workers focus on singles tasks
1. Efficient and productive
2. McDonald’s example – division of labor
C. Opportunity cost is based on relative rather than absolute resource requirements in the
production of goods.
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