Five questions every system must answer:- What goods and services will be produced?
- How will the goods and services be produced?
- Who will get the goods and services?
- How will the system accommodate change?
- How will the system promote progress?
- Who owns the productive resources?
- What decision-making process is used to allocate resources and production?
- What incentives guide economic decision makers?
Command System
An economic system in which all resources are government-owned and production is coordinated by central plan of the government
- state ownership of all resources
- central planners drive economic activity
- no competition
- consumers get low priority, capital goods high priority
- little freedom of choice
- planning is inefficient
- resources can be wasted by the state
- damage to environment
- no functioning price system
-Soviet Union
-Cuba
-North Korea
Market System
System characterized by private ownership of the means of production and the use of markets and prices to direct market activity. - private ownership the means of production (private property)
- free, competitive markets
- price drives economic activity
- “invisible hand” (Adam Smith)
(Ref: I, Pencil, price coordination)
the market (market exchange)
Another way of saying that would be "People answer the questions..."
- specialization
- division of labor
- trade
"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."
-Adam Smith, An Inquiry into the Nature & Causes of the Wealth of Nations, 1776
Limited role of government:
- maintain rule of law
- protect property rights
Big Points for Market and Mixed
- Efficiency: guides resources into production of goods and services most wanted.
- Incentives: Hard work, skill acquisition, innovation = higher standard of living.
- Freedom: coordination without coercion.
(But won't it be chaotic without the state to promote the general welfare?)
A few words on Efficiency
- evaluative term
- ratio of value of output to the value of input.
- objective, but must consider the values of those involved.
- efficiency can change with changes in valuations
- (what we value determines what we consider efficient or inefficient)
- One way of determining value is through relative prices
Productive Efficiency: occurs when a firm produces at the lowest possible cost per unit.
- firms that supply at the lowest cost preform best
- do it cheapest (least amount of resources)
- competition with other firms makes this essential
Allocative Efficiency: Occurs when a firm produces the output most valued by consumers.- competition makes it necessary for firms to produce what people will buy
- where marginal cost = marginal benefit
- unit produced is worth as much or more than anything else that could be produced with similar resources
Mixed Economy
- competitive markets
- gov’t. regulates market activity
- "cronyism"
- firm or person colludes with government officials to create unfair legislation and/or regulations which give them forced benefits they could not have otherwise obtained voluntarily.
Transitional Economy An economic system in the process of shifting from central to competitive markets
- converting state-owned enterprises into private enterprises (privatization)
- trying to become more competitive
What answers the questions: The market and the government
- competitive markets
- strong temptation for gov to intervene
- problem of selling off gov. owned firms
Traditional Economy
An economic system shaped largely by custom or religion
- family, religion, or custom play roles in organizing and coordinating economic activity
- had job your father did
- typical where you see subsistence agriculture
- limiting to people
- coercion
early societies,
Caste system in India,
“third world” countries
