Chapter 29 Comparative Economic Systems • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2000 South-Western College Publishing 1 In this chapter, you will learn to solve these economic puzzles: If the Soviets were foolish to Why did drivers in the former What did Adam Smith run their economy on fiveSoviet Union remove mean when he said thatthe an year plans, why do some windshield wipers and side “invisible hand” promotes institutions in a capitalistic mirrors whenever they the public interest? economy parked theirplan? cars? 2 What is an Economic System? The organization and methods used to determine what goods and services are produced, how they are produced, and for whom they are produced 3 What are the basic types of Economic Systems? • Traditional • Command • Market 4 What is a Traditional Economy? A system that answers the What, How, and For Whom questions the way they always have been answered 5 What is the Benefit of a Traditional Economy? There is little friction among members because relatively little is disputed 6 What are the Disadvantages of a Traditional Economy? Restricts individual initiative Lack of advanced goods, new technology, and growth 7 What is a Command Economy? A system that answers the What, How, and For Whom questions by central authority 8 What is the Structure of a Command Economy? It has a pyramid structure 9 The Command Economy Pyramid Supreme planning agency Specialized planning agencies Producing units Consuming units 10 What are the Strengths of a Command Economy? Economic change can occur very quickly Social welfare can be enhanced 11 What are the Weaknesses of a Command Economy? Decision makers have the power to be absolutely wrong Quality and variety of goods suffer 12 Price per side mirror (rubles) Central Planners Fixing Prices $80 S Shortage of 400 thousand side mirrors $60 $40 Price set by planners E $20 D 200 400 600 800 1000 Quantity of side mirrors (thousands per day) 13 Shortage of mirrors Planners set the price of mirrors below equilibrium 14 What is a Market Economy? An economic system that answers the What, How, and For Whom questions using prices determined by the interaction of the forces of supply and demand 15 Who was Adam Smith? The father of modern economics who believed that a free market economy acted like an “invisible hand” 16 What is the Invisible Hand? A phrase that expresses the belief that the best interests of a society are served when individual consumers and producers compete to achieve their own private interests 17 What is the advantage of a Market Economy? It provides a wide variety of goods and services that buyers and sellers exchange at the lowest prices 18 What are Criticisms of a Market Economy? • Lack of competition • Externalities • Lack of public goods • Income inequality 19 What is a Mixed Economy? An economic system that answers the What, How, and For Whom questions through a mixture of traditional, command, and market systems 20 What is Capitalism? An economic system characterized by private ownership of resources and markets 21 What is Consumer Sovereignty? The freedom of consumers to cast their dollar votes to buy, or not to buy, at prices determined in competitive markets 22 What is Communism? A stateless, classless economic system in which all the factors of production are owned by the workers and people share in production according to their needs 23 Who was Karl Marx? His criticism of capitalism advanced communism 24 What is Socialism? An economic system characterized by government ownership of resources and centralized decision making 25 What are the Characteristics of Socialism? Public ownership Centralization 26 What are the Strengths of Socialism? • An equitable distribution of income • Rapid growth is possible • No unemployment 27 What are the Weaknesses of Socialism? Inefficiencies occur Absence of entrepreneurship stifles growth 28 A Classification of Economic Systems Cuba China, former Soviet Union U.S., Canada, Western Europe Pure capitalism Pure socialism France, Mexico, Sweden, Latin Israel America, Japan Hong Kong 29 Key Concepts 30 Key Concepts • What is an Economic System? • What are the basic types of Economic Systems? • What is a Traditional Economy? • What is a Command Economy? • What is a Market Economy? • Who was Adam Smith? 31 Key Concepts cont. • • • • • • What is the Invisible Hand? What is a Mixed Economy? What is Capitalism? What is Communism? Who was Karl Marx? What is Socialism? 32 Summary 33 An economic system is the set of established procedures by which a society answers the What, How and For Whom to produce question. 34 Three basic types of economic systems are the traditional, command, and market systems. The traditional system is based on decisions made according to custom, and the command system answers the three economic questions through some powerful central authority. In contrast, the market system uses the impersonal mechanism of the interaction of buyers and sellers through markets to answer the What, How, and For Whom questions. 35 The Command Economy Pyramid Supreme planning agency Specialized planning agencies Producing units Consuming units 36 Capitalism is an economic system in which the factors of production are privately owned and economic choices are made by consumers and firms in markets. As prescribed by Adam Smith, there is an extremely limited role for government, and self-interest is the driving force, held in check, or regulated, by competition. 37 Consumer sovereignty is the determination by consumers of the types and quantities of products that are produced in an economy. 38 Socialism is an economic system in which the government owns the factors of production. The central authorities make the myriad of society’s economic decisions according to a national plan. The collective good, or public interest, is the intended guiding force behind the central planners’ decisions. 39 Communism is an economic system envisioned by Karl Marx to be an ideal society in which the workers own all the factors of production. Marx believed that workers who worked hard would be public spirited and would voluntarily redistribute income to those who are less productive. Such a communist nation described by Marx does not exist. 40 Chapter 29 Quiz ©2000 South-Western College Publishing 41 1. The economic system in which all of the basic decisions are made through a centralized authority, such as a government agency, is termed a a. market economy. b. capitalistic economy. c. command economy. d. traditional economy. C. To answer the three basic economic questions, the market economy uses the price system and a traditional economy is based on customs. 42 2. Command economies typically suffer from a. unemployment, but not underemployment. b. neither unemployment nor underemployment. c. both unemployment and underemployment. d. underemployment, but not unemployment. D. Command economies assign people jobs rather than allow the market system to determine wages and employment. 43 3. Adam Smith stated that the role of government in society should be to a. provide defense. b. enforce contracts. c. do absolutely nothing. d. both (a) and (b). D. Adam Smith believed in a limited role of the government to provide national defense, education, maintain infrastructure, enforce contracts, and little else. 44 4. When making economic decisions, Adam Smith urged society to a. follow the principle of self-interest. b. follow the principle of public interest. c. transfer wealth according to need. d. provide equal income for all citizens. A. Adam Smith stated “By pursuing his own interest he frequently promotes that of the society more effectively than when he really intends to promote it.” 45 5. The doctrine of laissez faire a. advocates an economic system with extensive government intervention and little individual decision-making. b. was advocated by Adam Smith in his book The Wealth of Nations. c. was advocated by Karl Marx in his book Das Kapital. d. none of the above. B. Laissez faire is a French expression meaning “allow them to act” stated differently, “The least government is the best government.” 46 6. In Adam Smith’s competitive market economy, the question of what goods to produce is determined by the a. “invisible hand” of the price system. b. “invisible hand” of government. c. “visible hand” of public interest. d. “visible hand” of laws and regulations. A. The “invisible hand” refers to a system where no central authority makes the key economic decisions, but rather decisions are make collectively by all consumers and producers in the economy. 47 7. Adam Smith wrote that the a. economic problems of the 18th-century England were caused by free markets. b. government should control the economy with an “invisible hand.” c. pursuit of private self-interest promotes the public interest in a market economy. d. public or collective interest is not promoted by people pursuing their self-interest. C. Adam Smith recognized that everyone making decisions based on their own self interest would enhance the public interest. 48 8. Adam Smith, in his book The Wealth of Nations, advocated a. socialism. b. an economy guided by an “invisible hand.” c. government control of the “invisible hand.” d. the adoption of mercantilism. B. Adam Smith advocated a laissez faire stance by government. That is, the government should provide the foundation for a free market system, but should not be a major participant in answering the questions of What, How, and for Whom. 49 9. The economic system in which private individuals own the factors of production is a. a planned economy. b. capitalism. c. collectivism. d. socialism. B. For answers a,c, d, resources or factors of production are owned by the government. 50 10. Which of the following is not a basic characteristic of capitalism? a. Economic decisions occur in markets. b. Factors of production are privately owned. c. Income is distributed on the basis of need. d. Businesses make their own product and price decisions. C. Karl Marx believed people would be motivated by the principle “from each according to his ability, to each according to his need.” 51 11. According to Karl Marx, under capitalism, a. profits would be shared fairly. b. incomes would be distributed equally. c. workers would be exploited and revolt against owners of capital. d. workers would actually own the factors of production. C. Karl Marx believed that private ownership and profits lead to exploitation. The result is a class struggle between a few “haves” and “havenots.” 52 12. Karl Marx predicted which of the following? a. market system would self destruct. b. “haves” would revolt against the “havenots.” c. wealthy were entitled to profits as their reward for risk-taking. d. none of the above. A. Karl Marx argued the market system would destroy itself because owners would go too far and pay starvation wages in order to maximize profits. 53 13. How many nations in the world today operate totally according to Karl Marx’s theory of communism? a. None. b. Several. c. Only the United States. d. Many. A. Under Marx’s idealized society of communism, people would distribute wealth according to need and no central authority would be necessary. 54 14. In Marx’s ideal communist society, the state a. actively promotes income equality. b. follows the doctrine of laissez faire. c. owns resources and conducts planning. d. does not exist. D. Under Marx’s idealized society of communism, individuals with ability would distribute the wealth of society according to each person’s need. 55 15. Karl Marx was a (an) a. 19th-century German philosopher. b. 18th-century Russian economist. c. 14th-century Polish banker. d. 19th-century Russian journalist. A. Karl Marx was born in Germany, the son of a lawyer. Marx was an outstanding student at Berlin University. In 1841, after receiving a doctorate in philosophy, he turned to journalism. 56 Internet Exercises Click on the picture of the book, choose updates by chapter for the latest internet exercises 57 END 58