CH2: Economic Systems Flashcards
What are the three central economic questions every system must answer?
- What to produce?
- How to produce?
- For whom to produce?
These address scarcity by determining allocation of limited resources.
What is an economic system?
It’s the structure by which a society decides how to allocate scarce resources, involving coordination between households, firms, government, and financial institutions.
What are the three main types of economic systems?
- Traditional system
- Command (centrally planned) system
- Market (capitalist) system
(Some economies are mixed, blending elements of all three.)
What characterizes a traditional economic system?
Production and roles are based on customs and inheritance. It is rigid, resistant to change, and prioritizes cultural continuity over economic efficiency.
What are the advantages and disadvantages of the traditional system?
✔️ Clear roles, cultural stability
✖️ Resists innovation, poor adaptability, low efficiency
What is a command economic system?
A central authority (typically the government) controls all production, distribution, and resource allocation decisions. It plans the economy in advance.
List advantages and disadvantages of a command economy.
✔️ Coordinated planning, reduced inequality, focus on social welfare
✖️ Inefficiency, lack of innovation, shortages or surpluses due to poor pricing signals
Give examples of countries with command economies.
Strong command: North Korea
Moderate command: China (transitioning), Vietnam (partial reforms)
What defines a market system?
Decentralized decisions by buyers and sellers determine production and prices via supply and demand. Private ownership and profit motive dominate.
What are the key conditions for a market to exist?
- At least one buyer and seller
- Product availability and demand
- Means of exchange
- Price agreement
- Legal/traditional contract enforcement
What role do prices play in a market system?
Prices act as signals of scarcity, guiding consumers and producers. They coordinate decentralized decisions.
What are the advantages and disadvantages of market systems?
✔️ Efficiency, innovation, consumer choice
✖️ Inequality, under-provision of public goods, market failures (e.g., pollution)
What is meant by ‘market capitalism’?
A system where most resources are privately owned and coordinated through voluntary market exchanges for profit, with minimal state intervention.
How does a market system answer the question: ‘What to produce?’
Goods and services are produced based on consumer demand and profitability.
How does a market system answer: ‘How to produce?’
Firms choose the most cost-effective method of production, depending on factor prices and technology.
How does a market system answer: ‘For whom to produce?’
Goods go to those with income or purchasing power, reflecting each person’s resource contribution.
What is the role of income distribution in a market system?
Income earned from contributing to production determines access to goods, creating inequality unless addressed by policy.
What is the role of competition in a market system?
It drives efficiency, innovation, and fair pricing. Among sellers, it protects consumers; among buyers, it regulates demand.
Why is real-world competition often imperfect?
Due to barriers to entry, monopolies, information asymmetry, and lobbying. These lead to market failures.
What is a mixed economy?
A system blending market mechanisms with government intervention. Most countries operate mixed economies for balance.
What type of economy does South Africa have?
A mixed economy, combining private ownership, self-interest, and market mechanisms with significant government intervention.
Who are the three major thinkers behind economic systems?
- Adam Smith – Father of capitalism, emphasized division of labour, free trade, and limited government.
- Karl Marx – Critic of capitalism, predicted it would be replaced by a classless system.
- John Maynard Keynes – Advocated for government intervention to manage aggregate demand.
What is Adam Smith’s main contribution to economics?
He justified free markets and saw wealth as national output satisfying human wants. Emphasized division of labour, free trade, and limited government role.
Summarize Karl Marx’s economic philosophy.
Labour is the source of value. Capitalists exploit workers for surplus value. Predicted capitalism would collapse and be replaced by a classless society.
What did Keynes argue against classical economists?
Keynes rejected Say’s Law, stating that aggregate demand—not supply—determines the level of economic activity.
What are the three major flows in an economy?
Production, income, and spending. These are continuous flows occurring simultaneously and are measured as flow variables over time.
What is the difference between stock and flow variables?
Stocks are measured at a point in time (e.g., dam water level), flows are measured over a period (e.g., income, production, spending rates).
What are the four main factors of production?
- Natural resources (land)
- Labour
- Capital
- Entrepreneurship
Why is entrepreneurship important?
Entrepreneurs combine resources, take risks, innovate, and drive production. They identify opportunities and convert them into viable products/services.
Is money a factor of production?
No. Money facilitates exchange but cannot itself produce goods/services. Production requires actual inputs like labour and capital.
What is meant by ‘choice of technique’ in production?
It refers to selecting the most efficient production method—labour-intensive or capital-intensive—based on resource availability and relative costs.
What is human capital?
The quality of labour based on skills, education, health, and experience, affecting productivity and economic output.
What is the role of technology in production?
Technology enhances productivity by enabling more output from the same inputs. It involves invention (discovery) and innovation (application).
What are the four types of income based on the factors of production?
- Rent (land)
- Wages/salaries (labour)
- Interest (capital)
- Profit (entrepreneurship)
Who are the four spending entities in the economy?
- Households (C)
- Firms (I)
- Government (G)
- Foreign Sector (X-Z)
What is the role of households in the economy?
They supply factors of production to firms and receive income (rent, wages, interest, profit), which they spend on goods/services to satisfy wants.
How do firms function in the economy?
Firms purchase factors of production from households, produce goods/services, and sell them in goods markets to generate profit (I = investment).
What is the economic role of government?
Government buys goods/services and labour, funds public services through taxes (T), and injects spending (G) into the economy.
Define exports and imports in the foreign sector.
Exports (X) are goods produced domestically and sold abroad. Imports (Z) are goods produced abroad and bought domestically.
What do exports and imports represent in the circular flow?
Exports are injections (income from abroad), imports are leakages (income spent abroad).
What is the relationship between production and income?
Production generates income through factor payments. Increasing total income requires increasing total production.
What is the difference between stock and flow variables?
Stock: Measured at a point in time (e.g., water level).
Flow: Measured over time (e.g., income per month).
How are income and spending related in the circular flow?
Firms’ spending on factors = household income. Households spend income on goods = firms’ revenue.
What is investment (I) in economics?
The act of firms purchasing capital goods for future production.
What does the government sector contribute to the circular flow?
Injection via G (spending) and leakage via T (taxes). Transfers support redistribution but don’t directly affect production.
How does the financial sector fit into the circular flow?
Households/firms save, funds go to financial institutions, which lend to firms for investment—supporting future production.
What is meant by a mixed economy in this context?
An economy combining private initiative with public sector involvement across all sectors of spending and production.
What is the role of financial institutions in the circular flow?
They act as intermediaries between surplus units (savers) and deficit units (investors), channeling savings (S) into investments (I).
What are examples of financial institutions in South Africa?
Banks (e.g., Standard Bank, Nedbank), insurance companies (e.g., Old Mutual, Sanlam), pension funds, and the JSE.
What are surplus and deficit units?
Surplus units save more than they spend (e.g., households), while deficit units spend more than they earn and require funds (e.g., investing firms).
How does saving (S) affect the circular flow?
Saving is a leakage from the circular flow because it represents income not spent on consumption.
How does investment (I) affect the circular flow?
Investment is an injection into the circular flow, increasing productive capacity by purchasing capital goods.
How do financial institutions support economic growth?
By channeling funds from savers to firms for investment, enabling expansion of production capacity.
Summarize the main leakages and injections in the circular flow.
Leakages: Saving (S), Taxes (T), Imports (Z)
Injections: Investment (I), Government Spending (G), Exports (X)
