Download Chapter 2, Section 4

Chapter 2
Section 1: Answering 3 Economic
Questions
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Different economic systems have evolved
in response to the problem of scarcity
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the method used by a society to produce and
distribute goods and services
Three economic questions
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What goods and services should be produced?
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Satisfy society’s needs and wants
Guns and butter trade-off
How should goods and services be produced?
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Who consumes goods and services?
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Determined by how societies choose to distribute
income
Factor payments are the income people receive
for supplying factors of production
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Landowners get rent
Workers receive wages
Economic Goals
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Economic efficiency
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Societies try to maximize what they can get for
the resources they have to work with
If a society can accurately assess what to
produce, it increases economic efficiency
Manufacturers won’t make records if everyone is
buying CDs
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Economic freedom
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Economic systems of different nations allow
different degrees of economic freedoms
Ability to make own choices
Economic Security and Predictability
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Economic systems reassure people that goods
and services will be available when they need
them and they can count on receiving expected
payments on time
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Government should provide a safety net- government
programs that protect people experiencing unfavorable
economic conditions
Economic Equity
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Society must decide the best way to divide the
economic pie
Should everyone get the same or should one’s
consumption depend on how much one produces?
Equal pay for equal work? Society does not value all
jobs equally
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Economic growth and innovation
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Nation’s economy must grow for a nation to improve its
standard of living
 Level of economic prosperity
Additional goals
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Environmental protection
Full employment
Universal medical care
Etc.
Must prioritize goals
Four Economic Systems
An economic system is the method used by a society to
produce and distribute goods and services.
Traditional economies rely
on habit, custom, or ritual to
decide what to produce, how
to produce it, and to whom to
distribute it.
In a market economy
economic decisions are made
by individuals and are based
on exchange, or trade.
In a centrally planned
economy the central
government makes all
decisions about the production
and consumption of goods
and services.
Mixed economies are
systems that combine tradition
and the free market with
limited government
intervention.
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Chapter 2, Section 1
Section 2: The Free Market
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A market is an arrangement that allows
buyers and sellers to exchange things
Why markets exist
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Specialization- the concentration of the
productive efforts of individuals and firms on a
limited # of activities
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Makes us more efficient- easier to learn one task
or a few tasks than to learn them all
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Buying and selling- we need markets to sell what
we have and to buy what we need
Free market economy
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Individuals answer the three economic questions
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Shows how individuals and
businesses exchange
money, resources, and
products in the marketplace
Households and firms
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Households own the
factors of production (land,
labor, capital)
Also the consumers of
goods and services
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Households pay
firms for goods
and services.
Firms supply
households with
goods and services.
Households supply
firms with land,
labor, and capital.
Firms pay households
for land, labor, and
capital.
A business, or firm, uses
resources to produce a
product, which it then sells.
Firms transport “inputs,” or
the factors of production,
into “outputs” or products.
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The factor market is where firms purchase
the factors of production from households
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Rent land, hire workers, pay wages for labor
Profit is the financial gain made in a
transaction
The product market is where households
purchase the goods and services that firms
produce
Self-Regulating Nature of the
Marketplace
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Competition and our own self-interest keep
the marketplace functioning
Self- Interest
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Adam Smith
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Economy is made up of countless individual
transactions
In each transaction, the buyer and seller consider
only their self-interest, or their own personal gain
 It is the motivating force in the free market
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Competition
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Consumers have the incentive to look for a lower price
 The hope or reward of the fear of punishment that
encourages a person to behave in a certain way
Firms seek to make greater profits by increasing sales
While self-interest is the motivating force behind the
free market, competition is the regulating force
Competition is the struggle among producers for the
dollars of consumers; the rivalry among sellers to attract
customers while lowering costs
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The Invisible Hand
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Self-interest and competition work together to
regulate the marketplace
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Self-interest spurs consumers to purchase certain
goods and services and firms to produce them
Competition causes more production and
moderates price
All this happens without any central plan or
direction
Adam Smith called this “the Invisible Hand”
Advantages of the Free Market
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Economic Efficiency
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Economic Freedom
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Self-regulating therefore it responds efficiently to rapidly
changing conditions
Highest economic freedom of any system
Workers work where they want, firms produce what
they want, individuals consume what they want
Economic Growth
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Competition encourages innovation and growth
Section 3: Centrally Planned
Economies
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How is it organized?
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Central gov’t, rather than individual producers
and consumers, answers the key questions of
production and consumption
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What items to produce?
How to produce them?
Who gets them?
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Government Control of Factor Resources
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Government owns land and capital
In a sense, owns the labor too
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Controls where people work and the wages they
are paid
Directs workers on what to produce and how
much to charge
Self-interest and competition are absent from the
system
Socialism/ Communism
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Often used interchangeably
Socialism
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Social and political philosophy based on the
belief that democratic means should be used to
distribute wealth evenly throughout a society
Real equality can only exist when political
equality is coupled with economic equality
Socialism can be present in a democracy
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Communism
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Political system that is characterized by a
centrally planned economy with all economic and
political power resting in the hands of the central
gov’t
Can only come from violent revolution
Authoritarian- strict obedience from their citizens
and do not allow individuals freedom of judgment
and action
Former Soviet Union
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1917
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Czar Nicholas II forced from throne
Taken over by Bolsheviks led by Vladimir Lenin
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Renamed themselves communists
Murdered Czar and children
Central planning introduced
Soviets concerned with building national power
and prestige
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Best land, labor, capital went to military, space
program, etc.
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Soviet agriculture
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Created large state-owned farms and collectives
State-run farms
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Collectives
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Provided w/equipment, seed, fertilizer
Workers worked for wages
Farms leased from the state to groups of peasant
farmers
Farmers managed operations BUT had to produce
what the gov’t instructed
Received a share of what they produced
Little incentive to work hard and produce better
quality of goods
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Soviet Industry
 State-owned factories
 Defense, space program, heavy industry were
priorities
 Consumer goods were stuck with leftover, lower
quality resources to create their products
Soviet Consumers
 Consumer goods were scarce and usually of poor
quality
 Often waited in line to purchase goods
 Some goods- like meat- were rarely available
Problems
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Poor quality, serious shortages
Almost always falls short of ideals upon
which the system is built
Cannot meet consumers needs and wants
Workers lack incentive to work hard
Lacks flexibility to adjust to consumer
demands
Sacrifice individual freedoms in order to
pursue societal goals
Section 4: Modern Economies
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Most modern economies are a mixture of
economic systems
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Most blend the market with gov’t intervention, or
involvement, in the marketplace
There has been a movement from less to
more gov’t involvement
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Laissez faire gov’t regulation
How is the gov’t involved in our economy?
Government’s Role in a Mixed Economy
In a mixed
economy,
Product market
the government
purchases goods
and services in the
product market,
and
purchases land, labor,
and capital from
households in the
factor market.
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Factor market
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Chapter 2, Section 4
Comparing Mixed Economies
An economic system that permits the conduct of business with minimal
government intervention is called free enterprise. The degree of
government involvement in the economy varies among nations.
Continuum of Mixed Economies
Centrally planned
Free market
Iran
North Korea
Cuba
South Africa
China
France
Botswana
Russia
Greece
United Kingdom
Canada
Peru
Hong Kong
Singapore
United States
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
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Chapter 2, Section 4