Chapter 2: Economic Systems Flashcards
economic system
A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem; a method of organizing an economy, of which the market system and the command system are the two general types.
Why do countries need economic systems?
To respond to the problem of scarcity
What does the economic system determine ?
- What goods are produced
- who gets them
- how to accomodate change
- how to promot technological change
What are the 4 major role players in economic systems?
- Households
- Business enterprise
- the government
- foreign sector
market
Any institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of a particular good or service.
market system
All the product and resource markets of a market economy and the relationships among them; a method that allows the prices determined in those markets to allocate the economy’s scarce resources and to communicate and coordinate the decisions made by consumers, firms and resource suppliers.
Where does the majority of countries’ economic systems lie?
Somewhere between laissez-faire capitalism and command sytems.
This is called a market system.
Define laissez-faire capitalism
- The literal translation is “allow to do” or “let it be”, with the idea being “let the people do as they choose”
- The government’s role is limited to pretecting private propery and establishing a legal environment in which contracts are enforced and people interacts in markets to buy and sell goods services and resources.
Why would one want to implement laissez-faire capitalism
- Some believe that govenrments are corrupet by special interests that use the government’s economic influenc to benefit themselves rather than society at large.
- The government infering in the economy might reduce human welfare.
command system
A method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; command economy; communism.
How is production determined within a command system?
The central planning board determines production goals for esach enterprise and specifies the number of resources allocated to each enterprise so that it can reach its productoin goals.
The division of output between capital and consumer goods are centrally decided, and capital good are located among industrield based on teh central planning board’s long-term priorities.
What are 2 main problems that led to the demise of the command system?
- Cooordination problem
- The incentive problem
Describe the coordination problem
Central planners had to coordinate millions of individual decisions by consumers, resource supppliers and businesses, and establish a realistic annual production target.
They had to make available all the necessary inputs such as labour, machinery, electric power etc for production.
Because outputs of many industries serve as inputs ot other industrier, if one single industry failed to meet its output target, it caused a big chain reaction or repurcssions.
Then other producers can’t meet their targets either, and eventually the chain reaction spreats to multiple firms that need th ouptut that was dependant on original firm that failed to meet its output.
Describe the incentive problem
- Central planner determined the output mix.
- When they misjudged the the output mix targets, persistant surplus and shortages arose.
- Yet, the managers who oversaw the produciton of these goods were rewarded for meeting their assigned production goals regardless of surplus of shortages.
- So they had no incentive to adjust procustin in response to shortages and surplus.
- There were no fluctuation in prices and profitability to signal more or less of certain products was desirded.
- Thus many products were unavailable or in short supply while other products were overproduced and sat for months or years in warehouses.
Why did the command systems of the Soviet Union lack entrepreneurship?
Central planning did not trigger the profit motive, not did it reward innovation and enterprise.
What was the route for getting ahead in the command system?
Participation in the political hierarchy of the Communist Party
Moving up in the hierarchy, meant better houseing, better access to health care, and the right to shop in special stores.
Market system criteria
- Private property
- Freedom of enterprise
- Self interes
- competion
- market and prices
- technology and capital goods
- Specialization
- Division of labour
- Government intervention in market
- Five fundamental questions
Command Syste critera
- Government owned property
- The government makes the choice of what, how and for whom
- No incentive to work or choose for own self interest
- No competion
- Prices determined by government
- THe central government decides on what is used and how
- The government decides on where to specialize in what
- Division of labout is government contorolled
- Full government control
- Five fundamental questions solved by central government decisions
Criterai of Lassez-Faire market system
- Mostrly privately owned property
- Freedom to make choices and start enterprise
- Completely self interest driven
- Full market competion between buyers and sellers
- Choices are freely driven by price-mechanims
- Constant drive by individual and firms to improve technology and obtain more capital goods
- Specialization is determined by price mechanism
- Labour market driven bases on individual choices
- Very limited government control
- Solved by individuals and firms driven by the price mechanism.
