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Economic Systems Economic Systems Chapter

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									Economic Systems
     Chapter 2
                 Key Concepts
   Pure command                 The Soviet model
    economic systems             Economic systems and
   Pure market economic          social well-being
    systems                      Surplus
   Transitional economies       Shortage
   Competitive markets          Turnover tax
   Monopolistic markets         Infrastructure
   Imperfectly competitive
    markets
Economic Systems: Two Sides of
        the Spectrum

   Cold war between the United States and the
    Soviet Union (the USSR)

   Two very different economies

   Dissolution of the USSR in December 1991

   The ongoing transition process
The Former Soviet Union
        The Continuum of Economic
                 Systems

   All economies in the world fall in
    between the two classes of economic
    systems:

       Pure market economy

       Pure command economy
           Pure Market Economy

   Pure market economy: economic system based on
    private ownership and control of resources, known as
    private property rights, and coordination of resource-
    use decisions through markets

       Private ownership of resources

       Decentralized decision making coordinated through markets

       Examples: U.S., Canada in early 1800s
        Pure Command Economy
   Pure command economy: economic system characterized by
    state ownership and/or control of resources and centralized
    resource-use decision making

       Mirror image of pure market economy

       State ownership of resources

       Centralized planning

       Markets are not necessary in pure command economies

       Examples: the Soviet Union, North Korea, Cuba
                 Mixed Systems

   Mixed systems

       Economies that combine elements of the pure
        market and pure command economies

       Examples: US, Canada, South Korea, Japan, China,
        Vietnam today

       Transitional economies: a nation in the process of
        replacing an economic system of command and
        control with the one based on market principles
        (former USSR and Eastern Europe)
           Market Structures

   Purely competitive markets

   Purely monopolistic markets

   Imperfectly competitive markets
     Purely Competitive Markets

   Large number of buyers and sellers

   Standardized product

   Prices are free to move up or down

   No obstacles to enter the market

   Buyers are free to choose who to buy from
    Purely Monopolistic Markets

   Only one seller of the product

   The seller can set the price at any level

   The seller can block potential entrants from
    entering the market

   Higher prices and lower quantities for
    consumers
    Imperfectly Competitive Markets


   Exhibit characteristics of both pure
    markets and purely monopolistic
    environment

   Most markets are imperfectly
    competitive
              Demand: Re-cap

   Demand schedule and demand curves

   Law of demand

   Factors influencing demand
       Consumers’ income
       Prices of related goods
       Consumers’ tastes
       Consumers’ expectations
       Number of consumers
Changes in Quantity Demanded
 versus Changes in Demand
         Factors Changing Demand
   Consumers’ incomes
        Normal good: the one whose demand increases as incomes rise (most goods are
         normal)
        Inferior good: the one whose demand decreases as incomes rise (typically old-
         fashioned goods, goods for the poor people)

   Changes in related prices
        Substitute goods: two goods for which an increase in the price of one leads to an
         increase in the demand for the other
        Complementary goods: two goods for which an increase in the price of one leads to a
         fall in the demand for the other

   Changes in consumers’ tastes or expectations
        When tastes change in favor of a good, demand shifts outward (you want to buy more
         at each price)
        Advertising, health information, life style changes…

   Changes in the number of consumers
        More consumers buy more causing the outward shift of the demand curve
                Supply: Re-Cap

   Supply schedule and supply curve

   Law of supply

   Factors influencing supply
       Cost of production
       Prices of goods related in production
       Sellers’ expectations
       Number of sellers of the product
Changes in Quantity Supplied
 versus Changes in Supply
         Factors Changing Supply
   Changes in cost of production
        Increase in production costs pushes the supply curve inwards (at each
         price of output suppliers are willing to produce less)
        Advances in technology push the supply curve outwards

   Prices of goods related in production
        Increases in price of related goods reduces the supply

   Sellers’ expectations
        Expectations of increased prices in the future reduce the current supply
        Expectations of improved economic climate increase supply

   Changes in number of sellers
        More suppliers produce more
Competitive Market Price
    Determination
                              Equilibrium
   Equilibrium price is the price at which the sellers of a product wish to sell
    exactly as much as the buyers want to buy

   Equilibrium quantity purchased is the quantity of the product that is actually
    exchanged at the equilibrium price

   Effects of a price above equilibrium
        Prices above equilibrium level result in surplus
        Resources used to produce the surplus amount (of e.g. pizza) could be better used
         producing something else (pressure to reallocate)
        Surplus exerts pressure on producers to reduce prices

   Effects of a price below equilibrium
        Prices below equilibrium level result in shortage
        Shortages indicate that more resources should be used to produce the product
        Shortages exert pressure to increase prices
                     The Soviet Model
   War Communism (1917-1920)
        No market allocation of resources
        Nationalization of important industries
        Forced requisition of agricultural output
        Elimination of private property rights and markets

   New Economic Policy (1920-1928)
        Re-cap: tragedy of the commons
        Mixed-command economy through return to private property rights
        Reintroduction of the market as chief mechanism of resource allocation

   System of Central Plan (1928)
        Centralized planning
        Control
        100 ministries produced 14000 pages of plans each year for the production and
         distribution of 24 million products
        Planning problem: how much to produce (quantities) and how to produce
         (technologies)
        Huge coordination problems resulted in a limited scope of choice
        Market Economy Reaction to
            Changes in Demand
   Suppose rising incomes push demand curve
    outwards
       Prices increase
       Quantities increase

   Suppliers react to increased prices by
    producing more (outward shift of the supply
    curve)
       Quantities increase yet more
       Prices go down (but maybe not down to the
        previous equilibrium level)
Market Economy Reaction to a
     Change in Demand
    Command Economy Reaction to
        Changes in Demand
   The supply curve is vertical in the command economy meaning whatever the
    price, the output level stays the same

   Prices indicate little if anything about the cost of producing a product

   Profits get siphoned off by a turnover tax (like a sales tax)

   Prices would be held down to the market-clearing level by providing a subsidy
    to the loss-making industries

   Increases in demand (e.g. due to changes in tastes) result in shortages since
    central planners keep their plan targets fixed

   Even if prices are allowed to increase, all additional profits go to the state
    through the use of turnover tax

   Prices do not serve as signals for optimal allocation of resources
Command Economy Reaction to a
     Change in Demand
Relative Position of the Soviet
      Consumer in 1985
Former Soviet Republics,
      2000-2001

								
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