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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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