“Introduction to Economic Systems”
• What key economic questions must
every society answer?
• What basic economic goals do societies
• What types of economic systems exist
What is an economic system?
The method used by a
society to produce and
distribute goods and
The Three Questions that Determine
a Societies Economic System
Because ALL economic resources are scarce,
every society must answer three questions:
– What goods and services should be
• Guns or butter?
– How should these goods and services be
• What combination of factor resources
should we use?
– Who consumes these goods and
• How will income be distributed?
Societies answer the three economic questions based on their goals
Economic efficiency Making the most of resources
Economic freedom Freedom from government intervention in
the production and distribution of goods
Economic security Assurance a safety net will protect
and predictability individuals in times of economic disaster
Economic equity Fair distribution of wealth
Economic growth Innovation leads to economic growth, and
and innovation economic growth leads to a higher
standard of living.
Other goals Environmental protection, variety
Four Economic Systems
An economic system is the method used by a society
to produce and distribute goods and services.
Traditional economies rely
on habit, custom, or ritual to In a market economy
decide what to produce, economic decisions are
how to produce it, and to made by individuals and
whom to distribute it. are based on exchange, or
In a centrally planned
economy the central Mixed economies are
government makes all systems that combine the
decisions about the free market with limited
production and government intervention.
consumption of goods and
Comparing Economic Systems
Economic System Who answers the 3 ?’s
• Traditional • Custom
• Market • Individuals
• Centrally Planned • Central Government
• Mixed • Individuals with some
The Free Market System (a.k.a. Capitalism)
Why do markets exist?
Markets exist because none of us produces
all the goods and services we require to
satisfy our needs and wants.
A market is an arrangement that allows
buyers and sellers to exchange goods and
Specialization is the concentration of the
productive efforts of individuals and firms on a
limited number of activities.
Circular Flow Diagram of a Market Economy
• In a free market monetary flow
economy, households physical flow
and business firms use
markets to exchange
products. Households Firms
own the factors
and consume goods and physical flow
services. monetary flow
Adam Smith (1723-90)
• Scottish social philosopher and professor
• “An Inquiry into the Nature and Causes of
the Wealth of Nations” (1776)
– 10 years to write
– 5 volumes
• “Laissez faire”
• The Invisible Hand
– Self Interest (Motivating Force)
– Competition (Regulating Force)
Advantages of the
Economic Efficiency Free Market
As a self-regulating
system, a free Economic Freedom
market economy is Free market economies have
efficient. the highest degree of
Economic Growth economic freedom of any
encourages Additional Goals, i.e. variety
innovation, free Free markets offer a wider
markets encourage variety of goods and services
growth. than any other economic
Centrally Planned Economies
Organization of Centrally Planned Economies
In a centrally planned economy, the government
owns both land and capital. The government
decides what to produce, how much to produce,
and how much to charge.
Socialism is a social Communism is a political
and political philosophy system characterized by a
based on the belief centrally planned economy
that democratic means with all economic and
should be used to political power resting in the
distribute wealth hands of the government.
evenly throughout a Communist governments are
society. authoritarian in nature.
• German philosopher
• Radical approach to fix the problems in free
• Communist Manifesto (1848) with Frederick
• Argued that history is a series of class struggles
between the rich capitalists and the working
• He believed that eventually workers needed to
unite and revolt against the capitalists. This
revolution would create a classless society.
Frederick Engels Karl Marx
The Soviet Union
The Soviet Experiment
• Factors of production controlled by the state
• Resources= armed forces, space program, capital
• Government committees decided the quantity,
process and distribution of products
• The government created large state-owned farms
• Little incentive to produce, decline in the
production of goods.
Problems in Centrally Planned Economies
• Poor-quality goods, shortages, and
• Fail to meet consumer needs and wants
• Little individual incentives to work
• Lack of innovation
• Expensive and inflexible government
• Sacrifice of individual freedoms
• It is doubtful that any
nation can exist
successfully under a pure
centrally planned economy or a
pure market economy.
• Most economies mix features of
An economic system that permits the conduct of business with minimal
government intervention is called free enterprise. The degree of
government involvement in the economy varies among nations.
Nations are placed on a continuum (a range with no clear divisions) of
mixed economies. On one end are centrally planned economies and
on the opposite end are free markets economies.
Continuum of Mixed Economies
Centrally planned Free market
Iran South Africa France United Kingdom Hong Kong
North Korea China Botswana Canada Singapore
Cuba Russia Greece Peru United States
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
Comparing Mixed Economies
Chapter 3 and 13
Tradition of Free Enterprise
The Economic Trade-off (Freedom
Rights and Roles of the American Consumer
• Property Rights
The Role of Government
1. Protect the Public Interest
3. Promote Growth and Stability
Gross Domestic Product
Gross Domestic Product
The main indicator used to determine overall
health of the economy is gross domestic
product (GDP) which is the dollar value of
all final goods and services produced within
a country’s borders in a given year.
This will allow them to better determine
upcoming business cycles to determine
prosperity, recession or depression.
Limitation of GDP
• Non-market activities
• Underground economy
• Quality of life
GDP vs. GNP
Annual income earned by
US owned firms and citizens.
Types of Unemployment
1. Frictional Unemployment- Occurs when people change jobs,
get laid off from their current jobs, take some time to find the
right job after they finish their schooling, or take time off from
working for a variety of other reasons
2. Structural Unemployment- Occurs when workers' skills do not
match the jobs that are available. Technological advances are
one cause of structural unemployment
3. Seasonal Unemployment- Occurs when industries slow or shut
down for a season or make seasonal shifts in their production
4. Cyclical Unemployment- Unemployment that rises during
economic downturns and falls when the economy improves
The Bureau of Labor Statistics
determines the unemployment rate (% of
the labor force that is unemployed) each
Getting Everyone To Work!!!!
• Economists generally agree that in an economy
that is working properly, an unemployment
rate of around 4 to 6 percent is normal.
• Sometimes people are underemployed, that is
working a job for which they are over-
qualified, or working part-time when they
desire full-time work.
• Discouraged workers are people who want a
job, but have given up looking for one.
Full employment is the level of employment reached
when there is no cyclical unemployment.
• Inflation is a general increase in
• Inflation limits purchasing
power (the ability to purchase
goods and services).
To Market, To Market
• The consumer price index (CPI) is
computed each month by the Bureau of
• This is a measure of the price of a typical
consumers “market basket”.
What is in the basket?
There are over two hundred categories of products that are
included in the basket. These categories fall under 8
FOOD AND BEVERAGES
EDUCATION AND COMMUNICATION
OTHER GOODS AND SERVICES
What’s the big deal?
The three main problems caused by inflation are:
–Reduced Purchasing Power
–Erosion of Interest Income
–Erosion of Wages/Income
The Poverty Problem
Although the free market is the most
successful economic system at producing
wealth—distribution is HIGHLY uneven.
The poverty threshold is an income level
below what is needed to support families or
households. What is the current
POVERTY...THE FORGOTTEN STATE
Who does the government provide
a safety net for?
Type of Program Description Example Example
Cash Transfers Direct payment of cash to qualifying Temporary Unemployment
individuals Assistance to Compensation
In-Kind Benefits Goods and services for free or Food Stamps Subsidized
reduced prices housing
Medical Benefits Health insurance to those that cannot Medicare Medicaid
provide it for themselves
Education Benefits Federal, state, and local government Pell Grants Head Start
all provide money for the poor and
disabled to ensure all people receive