Economic Systems

AP Macroeconomics AP Microeconomics Economics

Economic systems must answer three questions

What to produce?

How to produce?

For whom to produce?

Different Kinds of Economic Systems

Traditional Command or Planned Economy Free Market or Pure Capitalism Mixed Economies

Traditional Economic System

A traditional economy is a system where traditions, customs, belief systems, and inheritance determine the answer to the three economic questions.

Traditional Economic System

What to produce?

How to produce?

For whom to produce?

Traditional Economic Systems

A traditional economy is a system where traditions, customs, belief systems, and inheritance determine the answer to the three economic questions. While there may be no nation on Earth today that has a purely traditional economy, there are regions around the world where this type of economy is still prevalent. (under-developed areas in South America, Africa, Asia) The World Bank estimates that this type of economy is still prevalent among 400 million indigenous people across the world. The economy works through bartering and trading, and there is very little of that because so little surplus is produced. In traditional economies, most produce only enough to keep their families alive. Any surplus in a traditional economy may go to a landowner or ruling authority. Traditional economic systems are usually based on subsistence-based agriculture

Command Economy
The central government or authority determines the answers to the three economic questions. The central government owns and manages the economic resources. The government is the final authority to make decisions regarding production, utilization of the finished industrial products and the allocation of the revenues earned from their distribution.

Command or Planned Economy

What to produce?

How to produce?

For whom to produce?

Examples of Command Economies

North Korea
Vice Guide to North Korea - Bing Videos North Korea has a central government and economy under the rigid control of the communist Korean Workers Party While other centrally planned economies have opted for economic reform and liberalization of trade and free markets, North Koreas regime seems determined to maintain control.

North Korea
All natural resources, railroads, aviation, transportation, postal and communicational institutions, major factories, businesses, ports and banks are owned by the state. The country permits very limited forms of personal ownership, i.e. of personal saving, home appliances and everyday articles of consumption. Individuals are free to dispose of their personal belongings and their right of inheritance is also allowed. However, no personal ownership is allowed of the factors of production.

Disadvantages of a Planned Economy

Central planners cannot effectively coordinate production; therefore, shortages and surpluses exist Important valuable resources are not used in the most efficient manner Innovation and productivity are stifled

Free Markets or Capitalism

What to produce?

How to produce?

For whom to produce?

Free Market System or Capitalism

What to produce?
The competitive market determines what to produce (the invisible hand) Very limited government involvement (Laissezfaire) The market will produce those goods that can be sold at a profit. Consumers vote with dollars. Producers must adapt to the changing environment or be gone

Free Market
How to produce?
Because of competition and the desire to make a profit, firms have an incentive to minimize costs Efficient production methods are employed. (Resources tend to be allocated efficiently.) Technology and innovation are instrumental to success.

Free Market
For whom to produce?
Those willing and able to pay

Adam Smith

Adam Smith (1723-1790) was one of the first people to offer an explanation of how a market economy works. He is most remembered for his theories expressed in his book The Wealth of Nations.

Adam Smith called for a policy known as laissez faire, which means let them do (as they please). He insisted that government leave individuals as free as possible to pursue their own interests.

In Smiths view, businesses could provide the goods and services that consumers needed without the help of a central government telling them what to do. Individuals, each pursuing what is best for him or her, make decisions that ultimately benefit the nation. The invisible hand guides a nations resources to their most productive use.

Free Market
Advantages?
Resources are allocated efficiently (productive as well as allocative efficiency) Freedom of enterprise (own your own business) Freedom of economic choice (buy what you want, work where you want) Encourages innovation and new technology Variety of goods High degree of customer satisfaction

Free Market
Disadvantages?
The benefits of competition can be eroded by monopoly power Inequitable distribution of income (the land and capital are owned by the few) The young, old, disabled, poor are not able to pay for goods and services Market failure can occur because of lack of information, and not all costs (pollution) or benefits (public health) are properly accounted for.

Free Markets Require Constitutional Protections

The constitution must provide for the freedom of individual choice. A market system cannot function well without clearly defined, well enforced property rights Well enforced property rights send clear signals on who is rewarded for providing the resource. The government must ensure that contracts can be properly enforced

Mixed Economy
What to produce?

How to produce?

For whom to produce?

Mixed Economy
(A mixture of Command and Free Market Systems)

Government involvement in the economy is acceptable in varying degrees. Government might own key industries such as transportation and communication Government provides safety nets for the disadvantaged Government regulates and/or protects against market failures Government helps stabilize the economy through fiscal and monetary policy.

Example of Mixed Economy: Norway

It has a prosperous free market and large state ownership in certain key sectors such as petroleum, hydroelectric power, aluminum production, & telecommunications production.

Is Global Capitalism Good or Bad?

Most developmental economists believe that conditions of the worlds poor have improved in the past few decades as a result of modern global capitalism. Some people believe that international capitalism through foreign trade and investment tends to exploit the underdeveloped world.