Economics 1.6

Fundamental Economic

Concepts

Unit 1, Lesson 6

​Adapted by Mrs. Etheridge
From Mrs. Pretlow

Economic Systems

Objectives

I can describe the
characteristics of the three
main economic systems.

I can describe how each
economic system answers
the three basic economic
questions.

I can distinguish between
socialism and communism.

Essential Question:

Why isn’t the U.S.

considered 100% capitalist

economy?

Economic
Systems

To address scarcity, societies must answer three
questions:

1.

What should be produced?

2.

How should it be produced?

3.

For whom will it be produced?

The answers to these questions shape the economic
system a society has.

Economic system: the way a society uses its scarce
resources to satisfy its people’s unlimited wants

The 3 Basic
Economic Systems

Traditional economy: system in which
families, clans, or tribes make economic
decisions based on customs and beliefs
that have been handed down from
generation to generation.

Command economy: system in which the
government makes all economic decisions
with no regard for the wants of individuals

Market economy: system in which
individual choice and voluntary exchange
between producers and consumers direct
economic decisions

Traditional Economy

In the earliest times, all societies had
traditional economies to serve the
main purpose of survival.

●What: Society produces what
best ensures its survival

●How: Society decides the
method of production, which is
determined by custom and
tradition passed down through
generations

●Whom: Society distributes
products based on who needs
them

Marxism

Karl Marx (The Communist Manifesto and
Das Kapital) believed all of history is a
struggle between classes - big business
owners vs. workers. He believed as the rich
gain wealth, the workers get poorer due to
scarcity.

Marx predicted that eventually the poor
would overthrow the rich and transfer the
ownership of businesses to the public. With
the means of production owned by the
government, the class struggle would be
resolved and all citizens would share in the
wealth.

Command Economy

Command economies, sometimes called centrally planned
economies, generally fall into two categories:

1. Socialism: system in which the government owns some of the
   factors of production

2. Communism: system in which the government owns all the factors
   of production and there is little or no political freedom

Socialism

In democratic socialism, the
government owns the basic industries
(food, healthcare, energy, etc.), but
other industries are privately owned.

1.What: Producers and consumers
determine what goods will be
made, but the government
controls certain industries

2.How: producers mostly decide
this, but consumers and
government have some input

3.Who: consumers and producers
determine distribution

Communism

Usually paired with authoritarian
systems of government, where the
government requires absolute
obedience to those in power

The government controls all economic
activity, with the idea that all people are
treated equally

1.What: government decides what
to make

2.How: government assigns jobs
and decides the method of
production

3.Who: government distributes the
goods

Pros and Cons of Command Economies

Advantages

●Provide for everyone, especially the
sick and old

●Can produce items without seeking
profit, such as medicines, which
makes things cheaper

Disadvantages

●Economic decisions typically don’t
benefit small towns/cities

●Workers have little motivation to
work

●No property rights which gives
people little incentive to conserve
resources

●Severe shortages lead to a HUGE
black market

Adam Smith

In The Wealth of Nations, Smith challenged the idea
that mercantilism - a system by which the government
of the homeland controlled trade with its colonies - was
economically sound. Smith argued that a nation would
be wealthier if it engaged in free trade.

Smith believed that an “invisible hand” guides the
marketplace, where buyers and sellers benefit from
each transaction and adjust their behavior to satisfy
their economic self-interest. Adam Smith is considered
the founder of the market economic system.

Market

Economy

Market: any place where people buy and sell goods and
services

In a market economy, people’s economic behavior is motivated
by self-interest. Market economies have 7 features.

1.

Private property rights

2.

Limited government involvement

3.

Voluntary exchange

4.

Competition

5.

Consumer Sovereignty

6.

Specialization

7.

Profits

Capitalism

Capitalism: economic system that is based on
private ownership of the factors of production.
Operates on the belief that producers will
create the goods and services consumers
demand.

1.

What: Producers and consumers determine
what goods will be made (supply and
demand)

2.

How: Produces decide this based on what
consumers are willing and able to purchase

3.

Whom: Consumers and producers decide
this equally

Circular
Flow Model

Economists developed an economic model to
explain how the characteristics of market economies
combine.

Circular flow model: a visual representation of how
all interactions occur in a market economy

The model represents the two key decision-makers
in a market economy:

1.

Households - made up of individuals

2.

Businesses - sometimes referred to as firms

Product &
Factor
Markets

Product market: the market where goods and services
are bought and sold

●Ex. the local mall, dentist’s office, phone company,
online stores, etc.

●The suppliers of the product market are businesses

Factor market: the market where the factors of
production - land, labor, capital, and entrepreneurship -
are bought and sold

●In the factor market, businesses are the customers
and individuals are the producers

Pros & Cons of Market Economies

Advantages

●Economic and political freedom go
hand-in-hand

●Profit motivates business owners

●Wages and human capital increase
at the same rate

●Competition between businesses
keep prices low

Disadvantages

●The individual is the primary focus, so
there’s no mechanism for providing public
goods and services (i.e. national defense
and roads)

●The elderly and disabled are neglected

●Unequal distribution of wealth leads to
unequal opportunities

●Companies can become monopolies and
take advantage of workers

Mixed Economy

Mixed economy: system that had elements of traditional, market, and
command economies

The U.S. has a mixed economy, where several important industries (i.e.
energy) have been nationalized while some industries (i.e. NASA) have been
privatized

Nationalize: to make from private ownership to government ownership

Privatize: to change from government ownership to private ownership