Chapter 2 Flashcards
(32 cards)
Economic System definition
A particular set of institutional arrangements and a coordinating mechanism.
Differs in ownership of the factors of production and the method used to motivate, coordinate, and direct economic activity
Economic systems can be classified by:
Their degree of centralized or decentralized decision making.
Laissez-faire capitalism
‘Pure capitalism’.
Government intervention is minimal.
The government’s role is limited to protecting private property and establishing a legal environment in which: contracts are enforced
and people interact in markets to buy and sell goods, services and resources.
The Command System
Government owns most property resources and economic decision making is set by a central economic plan created and enforced by the government.
Government owned business firms produce according to government directives.
The central planning board determines production goals and specifies the number of resources allocated for each enterprise
The division of output between capital and consumer goods is centrally decided.
Capital goods are allocated among industries based on the central planning board’s long-term priorities.
Command System characteristics (summarised)
Government owns most property resources.
Economic decision making is set by a central economic plan.
Central planning board makes decisions.
The Demise of the Command Systems
The coordination problem and the incentive problem.
The coordination problem in the demise of the command systems.
Central planners had to coordinate millions of individual decisions by consumers, resource suppliers and businesses.
This became more difficult as economies expanded and the number of industries requiring intensive planning increased.
A lack of a reliable success indicator added to the problem as the major success indicator was a quantitative production target that central planners assigned.
The incentive problem in the demise of the command systems.
Managers had no incentive to adjust production in response to shortages and surpluses.
Command systems lacked entrepreneurship. Central planning did not trigger the profit motive, nor reward innovation and enterprise. Rather success was brought through participation in the political hierarchy.
The vast majority of the world’s economies utilise:
the market system (capitalism/mixed economy)
The Market System
Characterized by a mixture of centralized government economic initiatives and decentralized actions taken by individuals and firms.
The system features the private ownership of resources and the use of markets and prices to coordinate and direct economic activity.
Participants act in their own self-interest.
There are incentives for innovation and entrepreneurship.
The market system characteristics
Private property
Freedom of enterprise and choice
Self-interest
Competition
Coordination through markets and prices
Specialization
Division of labour
Geographic specialization
Use of money
Active but limited government
Private Property
Private individuals and firms own most of the property resources. Property rights encourage investment, innovation, exchange, maintenance of property and economic growth.
Freedom of enterprise
Entrepreneurs and private businesses are free to obtain and use economic resources to produce their choice of goods and services and to sell them in their chosen markets.
Freedom of choice
Owners can employ or dispose of their property and money as they see fit.
Workers can enter any line of work for which they are qualified.
Consumers are free to buy the goods and services that they want and are able to.
The invisible hand
Firms and resource suppliers seeking to further their own self interest and operating within the framework of a highly competitive market system, will also promote the public or social interest.
Competition controls self interest and self interest furthers the best interest of society.
Virtues/merits of the market system
Efficiency: efficient use of resources, techniques in organizing resources, production techniques
Incentives: encourages skill acquisition, hard work and innovation for economic rewards
Freedom: entrepreneurs and workers are free to further their own self interest, subject to rewards and penalties.
Emerging markets
Market systems that depend highly on government intervention in terms of infrastructure.
Typically display:
Volatile domestic markets
Evident economic growth rates
Dependence on global markets
Five Fundamental Questions
- 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?
What goods and services will be produced?
Goods and services produced at a continuing profit will be produced, contrary to those at continuing loss.
Profit
The difference between total revenue and total costs
Profit = TR - TC
Consumer sovereignty
In the market system, consumers are in command. Consumers spend their income on the goods they are most willing and able to buy
Rand votes
Consumers’ buying decisions determine the types and quantities of goods produced. They register
How will goods and services be produced?
In combinations and ways that minimize the cost per unit of output.
To achieve least-cost production:
Firms must use the right mix of labour and capital
Firms must employ the most efficient production technique.
