Chapter 2 Economic Systems

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					           Chapter 2
       Economic Systems
     WHO ANSWERS THE THREE
      ECONOMIC QUESTIONS?

 IF YOU KNOW THIS, YOU KNOW
WHAT KIND OF ECONOMIC SYSTEM
    YOU ARE LIVING UNDER!

* pay attention to the headings on each slide…don’t
                    ignore them *
                                         Three Economic Questions

 What goods and services should be produced?


 How should these goods and services be produced?


 Who benefits from these goods and services?


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  What Goods and Services Should be Produced?



 WHAT is an item that is over-produced in our
 economy? WHAT is an item that is under-produced
 in our economy?
                               underproduced    overproduced




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  What Goods and Services Should be Produced?



 Obviously we all need food and shelter, but there is a
 standard of living that is expected--so we have to
 decide what to produce to meet that standard.




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  Standard of living = the quality of life based on the ownership of necessities
                        and luxuries that make life easier.
  What Goods and Services Should be Produced?

 Recall Guns vs. Butter. How much is needed with
 respect to military spending? How much is wanted?




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 How Should Goods and Services Be Produced?

HOW Questions must be answered, such as:
Should we produce energy with oil or solar power?

Should teachers have                                                                QuickTime™ and a
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classes of 20 or 50?                                                                                                                                       QuickTime™ and a
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Should we have corporate farms                                                                                          QuickTime™ and a
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or small family farms?
          For Whom to Produce?
 The answer to the question of distribution
 (FOR WHOM to Produce?) is
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 distribute income.

 Who gets the income? …the ones who supply
 Land, Labor, Capital, and Entrepreneurship!
                  Factor Payments

Factor payments are the income people receive for
 supplying the factors of production (L,L,C & E).
    Land owners receive rent




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                 Factor Payments?


 Factor payments are the income people receive for
 supplying the factors of production (L,L,C & E).
    Land owners receive rent
    Laborers receive wages
                  Factor Payments


 Factor payments are the income people receive for
 supplying the factors of production (L,L,C & E).
    Land owners receive rent
    Laborers receive wages
    money lenders receive interest payments
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                    Factor Payments


 Factor payments are the income people receive for
 supplying the factors of production (L,L,C & E).
    Land owners receive rent
    Laborers receive wages
    money lenders receive interest payments
    Entrepreneurs receive profits

             income
                                                                                           expenses
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Economic Goals reflect Societal Values

The United States, Saudi Arabia, and Cuba answer the
    3 economic questions differently, based on the
  importance they attach to various economic goals.
 Cuba doesn’t value the same things we do, so their
        economy reflects their values, not ours.



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               Economic Efficiency

 Since resources are always scarce,
 using them always involves                                                     QuickTime™ and a
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 opportunity costs.
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 If a company chooses to produce gas-guzzling SUVs
 when society wants Hybrids, the company is
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 If a society can accurately assess what to produce, it
 increases economic efficiency!
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                                             Economic Freedom

 Nations have different economic systems.
  Each system allows different degrees of
  economic freedom.
 Some nations don’t allow the purchase or possession
  of particular items.

 Some nations don’t
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 allow entrepreneurship.                                                                          QuickTime™ and a
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Economic Security and Predictability

 Security: Most nations believe in providing some
 sort of safety net to help citizens in need: examples
 would be the elderly, the sick, & those who have lost
 jobs through no fault of their own.
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 Predictability: Most people also have the
 expectation that there will be food at the grocery
 store and fuel at the gas station when they need.
                 Economic Equity

 Societies have to decide how to divide
 the economic pie.
 Should everyone get the same portion
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 or should some people’s piece be bigger?

 Many people believe in equal pay for equal work.


 Lawyers make more than teachers, doctors make
 more than secretaries.
      Economic Growth and Innovation

 A nation’s economy must grow for a nation to
 improve its standard of living, especially if the
 population is growing!




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                       Economic Growth and Innovation

 Innovations in technology foster increases in
 efficiency. (More technology = more efficiency in
 making goods)

 Nomads    Agriculture Age     Industrial
 Revolution    Information Age.


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                                    Additional Goals

 Societies may have more goals than what we have
           talked about already, such as:
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               Full Employment
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 Every nation must prioritize its economic goals…they
           all come with trade-offs.
             Economies and Values

 4 different systems have been developed to address
 the 3 economic questions.

 Each system is a reflection of the society’s
 values. Try to figure out what each one values
 most.

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System 1: Traditional Economies                        QuickTime™ and a
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 Resources (economic decisions) are
    distributed by inheritance
   Social network gives everyone a purpose & function
    in society
   habit, rituals, & customs dictate decisions
   Revolves around family; work is divided by gender
    lines.
   Hunting & agriculture lie at the heart of lives & laws
   Less demand on the earth’s resources; goods are only
    produced if they are going to be consumed
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           System 1: Traditional Economies

 No over-production or surpluses most of the time;
  living at subsistence level (everyone has what they
  need, but not a lot more).
 Very few things in place to deal with disaster
 Most have no modern conveniences and have a low
  standard of living
 Very resistant to change, because no desire for goods
  the rest of the world has--they have no value in this
  lifestyle (except possibly for the younger generation!)
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          System 1: Traditional Economies

 Goals of a traditional economy are:
      1. Full employment (everyone works)
      2. Price stability (no inflation)
      3. Satisfactory rate of economic growth
                   (generally have as much or more than usual)
      4. Free trade with other nations (or tribes)
      5. Correct (fair) distribution of income
      6. Efficient allocation of resources (no wasting time)

 Examples: the Amish in midwestern America, the
 Eskimos in Alaska, the Masai tribe in Kenya and
 Tanzania…everyone before the Industrial Revolution
          System 2: Market Economies

 Economic decisions are made by individuals with no
 rules imposed on them by the government.

 Individuals determine what gets made and how and
 who profits from it

 Also called “free markets” or “capitalism”


 Examples…?
           System 2: Market Economies

 Examples: …guess what! There are no pure market
 economies. The government always imposes SOME
 rules. The closest thing to free market economies in
 the world are:
     the United States
     the United Kingdom
     Germany
     Netherlands
     Canada
       System 3: Command Economies

 In a centrally planned economy the government
 COMMANDS everything.

 The central government owns all the factors of
  production (anything productive: land, mines,
  buildings, businesses, forests…)
 The central government makes all of the
  decisions on how to answer the three questions.

 Examples…?
                     System 3: Command Economies


 Examples include: the FORMER Soviet Union, and
 the CURRENT Cuba, North Korea, and Vietnam.
 What do these countries have in common?….

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         System 3: Command Economies


 Examples include: the FORMER Soviet Union, and
 the CURRENT Cuba, North Korea, and Vietnam.
 What do these countries have in common?….

     They are communist countries. Under communism, the
      government dictates what is made, who is making it, at
      what price it will sell, and to whom it is sold.

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           System 4: Mixed economy

 Most modern economies fall in this “Mixed”
 category: market-based economic systems in which
 the government plays a role.

 The government usually “plays a role” by…
           System 4: Mixed economy

 Most modern economies fall in this category:
 market-based economic systems in which the
 government plays a role.

 The government usually “plays a role” by…
    Regulating industries (such as…)
           System 4: Mixed economy

 Most modern economies fall in this category:
 market-based economic systems in which the
 government plays a role.

 The government usually “plays a role” by…
    Regulating industries (such as…)

    Regulating minimum wage
           System 4: Mixed economy

 Most modern economies fall in this category:
 market-based economic systems in which the
 government plays a role.

 The government usually “plays a role” by…
    Regulating industries (such as…)

    Regulating minimum wage

    Imposing taxes (such as…)
           System 4: Mixed economy

 Most modern economies fall in this category:
 market-based economic systems in which the
 government plays a role.

 The government usually “plays a role” by…
    Regulating industries (such as…)

    Regulating minimum wage

    Imposing taxes (such as…)

    Imposing tariffs
           System 4: Mixed economy

 Most modern economies fall in this category:
 market-based economic systems in which the
 government plays a role.

 The government usually “plays a role” by…
    Regulating industries (such as…)

    Regulating minimum wage

    Imposing taxes (such as…)

    Imposing tariffs

    Imposing quotas
           System 4: Mixed economy

 Most modern economies fall in this category:
 market-based economic systems in which the
 government plays a role.

 The government usually “plays a role” by…
    Regulating industries (such as…)

    Regulating minimum wage

    Imposing taxes (such as…)

    Imposing tariffs

    Imposing quotas

    Regulating working conditions
             Why Do Markets Exist?

 Markets are a way to exchange what we have for
 what we want/need.

 None of us are self sufficient. You did not grow the
 cotton to make your shirt.

 You did not grow the wheat to make the bread for
 your sandwich.
               Specialization Rocks!

 Instead of doing everything ourselves, we specialize
 in one or a few products.
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 This makes us more efficient.                                             Qui ckTi me™ and a
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 I do not want to calculate my own taxes. I do want to
 teach. I specialize in teaching and someone else
 specializes in tax law. I pay them to calculate my
 taxes, and they pay taxes so I can teach their kids.
                Buying and Selling

 The typical person makes what they specialize in,
 sells it and then uses those wages to buy what they
 want/need.
   The Self-Regulating Nature of the Marketplace

 Why is it that firms and households cooperate in
 order to get what they need?
                    Greed is Good

 Why is it that firms and households cooperate in
 order to get what they need?

            Competition! Self-interest!
            … make everything work out.
                                     Adam Smith is brilliant
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 Adam Smith called this “THE INVISIBLE HAND.”
 He said…competition is good! Greed is good! Self-
 interest is good!

 In The Wealth of Nations, he wrote that in an
 economy, there are countless individual transactions.
 In each single transaction, the driving force is each
 person’s consideration of their own personal gain.
         Competition and Self-Interest

 Everyone’s self-interest is the regulating force that
 balances an economy:
       The circle of life…I mean economics

 Everyone’s self-interest is the regulating force that
 balances an economy:
      Individuals are trying to get the most for their money,
       The circle of life…I mean economics

 Everyone’s self-interest is the regulating force that
 balances an economy:
      Individuals are trying to get the most for their money,
      Firms are trying to make the most profit.
       The circle of life…I mean economics

 Everyone’s self-interest is the regulating force that
 balances an economy:
      Individuals are trying to get the most for their money,
      Firms are trying to make the most profit.
      Firms will compete with each other for sales.
       The circle of life…I mean economics

 Everyone’s self-interest is the regulating force that
 balances an economy:
      Individuals are trying to get the most for their money,
      Firms are trying to make the most profit.
      Firms will compete with each other for sales.
      This competition drives prices down.
               The Invisible Hand

 Adam Smith said that the economy decides on
 production and price without any central regulation.
 Each individual consumer or individual firm trying
 to get the best for itself will set proper production
 amounts and prices. [No one will produce what
 someone won’t buy! No one will sell at a price
 consumers won’t pay!] Adam Smith called this the
 INVISIBLE HAND.

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         Advantages of the Free Market

 Economic efficiency (no one will waste their own
  time or money)
 Economic freedom (no one telling you what to do)
 Economic growth (if I make more profit, I will buy
  more goods with it)

 Despite the advantages, it doesn’t exist
 anywhere!…on a large scale. No government can
 completely stay out of it. Why is that?!?!?!?
 How are Command Economies organized?

 Government Control of resources and production
   Government owns both land and capital

   Government decides
    What to produce
    How much to produce
    How much to charge
                          Socialism

 Socialism- The goal is to distribute wealth evenly,
 and the decisions are made by the citizens,
 democratically.
    Can be a democracy, but still centrally planned
    Government owns major industries like utilities
                      Communism

 The goal is to distribute wealth equally, but the
    people are not trusted to do it. Therefore, the
    government makes all the decisions of how to
    distribute the wealth.
   All economic and political power lies in the central
    government.
   Government is authoritarian in nature
   No individual freedom (or very little)
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                                    The Former Soviet Union

 Example of communism: the U.S.S.R. (fell in 1991)
 Allocated best land and capital to the military and
  space program
 The Soviet government was responsible for deciding
  the process (what, how, for whom) for 24 million
  goods

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Soviet agriculture

 Farmers worked for
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  daily wage

 Government provided
  equipment, seed, fertilizer

 Collectives were formed
   Large farm leased to peasant farmers

   Required to produce what the government told them to

   No incentive to produce better crops (couldn’t keep the profit)
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 Planners favored the defense industry
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 (GUNS over BUTTER)

 Consumer goods got the leftover resources


 Jobs were guaranteed…so no incentives given for
 good work (you couldn’t get fired; the government
 might reassign you but you always had a job)

 Illegal to be an entrepreneur
                Soviet Consumers

What was it like for the people?

 Goods scarce and poor quality
 Focus on quantity, not quality
 Vast housing shortages
 Vast food shortages

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     Problems with Command Economies

 Since there are no incentives, growth is nearly
 impossible

 System can’t meet consumers’ needs or wants


 Discourage change
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 Discourage innovation


 Decisions are over-complicated
             Why Mixed Economies?

 Limits of Laissez Faire (hands off)
               Why Mixed Economies?

 Limits of Laissez Faire (hands off)
   Market economies are great, but have limitations




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               Why Mixed Economies?

 Limits of Laissez Faire (hands off)
   Market economies are great, but have limitations

   If there is no government intervention, where do schools and
    roads, police and disaster relief come from?




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               Why Mixed Economies?

 Limits of Laissez Faire (hands off)
   Market economies are great, but have limitations

   If there is no government intervention, where do schools and
    roads, police and disaster relief come from?
   Laws are created protecting rights and contracts




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       Balance of Freedom and Control:
              A Mixed Economy
 Some goals are better met by governments:
    Can you think of some examples?




 Some are better met by the free market:
    Can you think of some examples?
Economic Terms



    Profit

     Loss
                                              Profit



income                                                 expenses

                                              minus

                                                                  = profit




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                                                     Loss



If   income                                                 expenses   is less
                                             minus
                                                                       than zero,
                                                                       then you
                                                                       have a
                                                                       LOSS
                                                                       instead of
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Government Regulation



  Minimum Wage
     Social Programs



     Social Security

being on a “fixed income”
Economic Terms



   Inflation
    Economic Terms



Private Property Rights
Economic Terms



 Competition

				
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