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									The Three Economic Questions
• Every society must answer three questions:
     – _____________ goods and services should be
     – __________________ should these goods and
       services be produced?
     – ______________ consumes these goods and

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Economic Goals
• Societies answer the three economic questions based
  on their ____________________.
                      Economic Goals

                      Economic efficiency   Making the most of resources

                      Economic freedom      Freedom from government
                                            intervention in the production and
                                            distribution of goods and services

                      Economic              Assurance that goods and services
                      security and          will be available, payments will be
                      predictability        made on time, and a safety net will
                                            protect individuals in times of
                                            economic disaster

                      Economic equity       Fair distribution of wealth

                      Economic growth       Innovation leads to economic
                      and innovation        growth, and economic growth leads
                                            to a higher standard of living.

                      Other goals           Societies pursue additional goals,
                                            such as environmental protection.

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Four Economic Systems
 An economic system is the method used by a society to
      produce and distribute goods and services.

  _____________________                   In a market economy economic
  economies rely on habit,                decisions are made by
  custom, or ritual to decide what to     individuals and are based on
  produce, how to produce it, and         exchange, or trade.
  to whom to distribute it.
  In a centrally planned economy          economies are systems that
  the central government makes all        combine tradition and the free
  decisions about the production          market with limited government
  and consumption of goods and            intervention.

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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 _____________________ is an     ________________________ is the
arrangement that allows buyers    concentration of the productive
and sellers to exchange goods     efforts of individuals and firms on a
and services.                     limited number of activities.

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The Free Market Economy
•   In a free market economy,
    households and business     Circular Flow Diagram of a Market Economy
    firms use markets to        Households pay     Product market
    exchange money and          firms for goods
                                and services.        monetary flow
    products.                                         physical flow

    own the factors of                               Firms supply
    production and consume                           households with
                                                     goods and services.
    goods and services.
                                    Households                                     Firms
                                                    Households supply
                                                    firms with land, labor,
                                                    and capital.

                                                      physical flow
                                                     monetary flow            Firms pay
                                                                              households for land,
                                                                              labor, and capital.
                                                    Factor market

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The Market’s Self-Regulating Nature
• In every transaction, the buyer and seller consider only
  their ________________________________, or their
  own personal gain. Self-interest is the motivating force
  in the free market.
• Producers in a free market struggle for the dollars of
  consumers. This is known as competition, and is the
  regulating force of the free market.
• The interaction of buyers and sellers, motivated by self-
  interest and regulated by competition, all happens
  without a central plan. This phenomenon is called “the
  ________________________________ hand of the

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Advantages of the Free Market
Economic Efficiency                  Economic _______________
• As a self-regulating system, a     • Free market economies have
  free market economy is               the highest degree of
  efficient.                           economic freedom of any
                                       economic system.
Economic ___________________
                                     Additional Goals
• Because competition
  encourages innovation, free        • Free markets offer a wider
  markets encourage growth.            variety of goods and services
                                       than any other economic

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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.

______________________ is a            _______________________ is a
social and political philosophy        political system characterized by a
based on the belief that democratic    centrally planned economy with all
means should be used to distribute     economic and political power
wealth evenly throughout a society.    resting in the hands of the

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The Former Soviet Union
• Soviet Agriculture
     – In the Soviet Union, the government created large state-owned
       farms and collectives for most of the country’s agricultural
• Soviet Industry
     – Soviet planners favored heavy-industry production (such as
       steel and machinery), over the production of consumer goods.
• Soviet Consumers
     – Consumer goods in the Soviet Union were ______________ and
       usually of __________________________

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Problems of a Centrally Planned Economy

   Centrally planned economies face problems of poor-
  quality goods, shortages, and diminishing production.

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The Rise of Mixed Economies
      Market economies, with all their advantages, have
                   certain drawbacks.

                       Limits of Laissez Faire
Laissez faire is the doctrine that    Governments create laws
government generally should           protecting property rights and
______________ interfere in the       enforcing contracts. They also
marketplace.                          encourage innovation through
                                      patent laws.

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Government’s Role in a Mixed Economy
In a mixed economy,         Circular Flow Diagram of a Mixed Economy
                                                    Product market
• The
                                                         monetary flow
  ____________________                                   physical flow
  purchases land, labor,
  and capital from
  households in the
  factor market, and
• Purchases goods and       Households
                                         expenditures                    expenditures   Firms

  services in the product

                                                         physical flow

                                                         monetary flow

                                                        Factor market

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  Comparing Mixed Economies
  • An economic system that permits the conduct of business with
    minimal government intervention is called free ________________.
    The degree of government involvement in the economy varies
    among nations.

 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

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The Basic Principles of Free Enterprise
            Several key characteristics make up the basic
                     principles of free enterprise.
1. ________________ Motive                 5. Free contract
     The drive for the improvement of          The right to decide what
     material well-being.                      agreements in which you
2. Open opportunity                            want to take part.
     The ability for anyone to             6. Voluntary exchange
     compete in the marketplace.               The right to decide what
3. Legal equality                              and when you want to buy
                                               and sell a product.
     Equal rights to all.
                                           7. _______________________
4. Private property rights
                                               The rivalry among sellers
     The right to control your                 to attract consumers.
     possessions as you wish.

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The Consumer’s Role
 A fundamental purpose of the free enterprise system is
 to give consumers the ____________________ to make
              their own economic choices.

Through their economic             Consumers can also make their
dealings with producers,           desires known by joining interest
consumers make their desires       groups, which are private
known. When buying products,       organizations that try to
they indicate to producers what    ____________________ public
to produce and how much to         officials to vote according to the
make.                              interests of the groups’ members.

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The Government’s Role
 Americans expect the government to protect them from
   potential problems that arise from the production of
 various products or the products themselves. We also
  expect assurance in the security of personal property.
      Laws that require companies to provide consumers with
      important information about their products, such as fuel
      efficiency of automobiles, side-effects of medication.
      Both state and federal governments’ involvement in concerns
      of the public as a whole, such as environmental protection,
      sanitary food production.

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Tracking Business Cycles
• Macroeconomics is the study of the behavior and
  decision making of entire economies.
• A business cycle is a period of a macroeconomic
  expansion followed by a period of
• One measure of a nation’s macroeconomy is gross
  domestic product (_________). GDP is the total value of
  all final goods and services produced in a particular

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Promoting Economic Strength

 Policymakers pursue three main outcomes as they seek
               to stabilize the economy.
• One aim of federal economic policy is to provide jobs for everyone
  who is able to work.
• For each generation of Americans to do better than previous ones,
  the economy must grow to provide additional goods and services.
• Stability gives consumers, producers, and investors confidence in
  the economy and in our financial institutions, promoting economic
  freedom and growth.

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Encouraging Innovation
   The government encourages the development of new
 technologies in several ways. ______________________
    is the process used to produce a good or service.

 • Federal agencies fund many         • A patent gives the inventor
   research and development             of a new product the
   projects. Also, new                  exclusive right to produce
   technology often evolves out         and sell it for 20 years.
   of government research.

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Public Goods
• A ____________ good is a shared good or service for
  which it would be impractical to make consumers pay
  individually and to exclude nonpayers.
     – Public goods are funded by the public sector, the
       part of the economy that involves transactions of the
     – A ___________________________ is someone who
       would not choose to pay for a certain good or
       service, but who would get the benefits of it anyway
       if it is provided as a public good. Non-exclusivity/
       Non-rivalrous consumption
     – Fireworks, roads, Police, etc.

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• An externality is an economic
  ________________________ of a good or service that
  generates benefits or costs to someone other than the
  person deciding how much to produce or consume.
     – The building of a new dam and creation of a lake generates:
            • Positive Externalities
                – A possible source of hydroelectric power
                – Swimming
                – Boating
                – Fishing
                – Lakefront views
            • Negative Externalities
                – Loss of wildlife habitat due to flooding
                – Disruption of fish migration along the river
                – Overcrowding due to tourism
                – Noise from racing boats and other watercraft

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Market Failures
 A market failure is a situation in which the market, on its
     own, does not distribute resources efficiently.


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The Poverty Problem

    The poverty threshold is an income level below that
    which is needed to support families or households.

• The poverty threshold is determined by the federal
  government and is adjusted periodically.
• ______________________ is a general term that refers
  to government aid to the poor.

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Redistribution Programs
            Cash transfers are direct payments of money
                         to eligible people.
  Temporary Assistance for Needy Families (TANF)
  This program allows individual states to decide how to best use
  federally provided funds.
  Social Security provides direct cash transfers of retirement income
  to the nation’s elderly and living expenses to the disabled.
  Unemployment compensation provides money to eligible workers
  who have lost their jobs.
  Workers’ Compensation
  Workers’ compensation provides a cash transfer of state funds to
  employees injured while on the job.

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Other Redistribution Programs
• Besides cash transfers, other redistribution programs
     In-kind benefits
     • In-kind benefits are goods and services provided by the
        government for ________________ or at greatly
        ______________ prices.
     Medical benefits
     • Health insurance is provided by the government for the elderly
        and disabled (Medicare) and for poor people who are
        unemployed or are not covered by their employer’s insurance
     ___________________________ benefits
     • Federal, state, and local governments all provide educational
        opportunities for the poor.

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