Chapter 2

Economic Systems and the American Economy*

Section 2

Economic Systems*

Define economic system

Way in which a nation uses its resources to satisfy its people’s needs and wants*

What three questions must all economic systems answer?

• What should be produced?*• How should it be produced?*

• For whom should it be produced?*

Does a pure economic system really exist?

No- they are all mixed economies to some degree

What are the major types of economic systems and their differences?

• Traditional• Command

• Market• Mixed*

Define traditional economy

System in which economic decisions are based on customs and beliefs that have been handed down from generation to

generation*

Traditional• Answers the three basic questions

according to tradition• Things are done, “the way they have

always been done.”• Economic decisions are based on customs and beliefs-often religious-

handed down from generation to generation*

Traditional

Examples• Inuit of North America

• San of the Kalahari in Africa• Aborigines of Australia

Traditional

Advantages:• Everyone knows their role

• Little uncertainty of what and how to produce, for whom is usually

themselves

Traditional

Disadvantages:• Discourages new ideas/technology

• Punishes people who break rules• Lower standard of living

Define command economy

System in which the government controls the factors of production and makes all decisions about their use*

Command• Government decides questions of

production• Example: Former USSR , Cuba, North

Korea, and China

CommandAdvantages:

• Speed in which resources can be rerouted (agriculture to industry)

• Little uncertainty-decisions made for you

• Some education, healthcare, public services, available at little or no cost

Command

Disadvantages:• Not designed for customer wants-basic

needs provided• Sacrifice for the good of the state and

benefit for future generations

Command

Disadvantages:• No incentive to work hard-just enough

to fill quota• Large bureaucracy

Command

Disadvantages:• Little flexibility-discourages change• Individual abilities not considered*

Define market system

System in which individuals own the factors of production and make

economic decisions through free interaction while looking out for their own and their families’ best interests*

Market• People and firms act in their own best

interests• Allow buyers/sellers to come together

to exchange goods or services• Ex. U.S., Japan, Germany

Define market

Freely chosen activity between buyers and sellers of goods and services

Market

Advantages:• Over time can adjust to change

• Individual freedom• Little government interference• Decentralized decision making

MarketAdvantages:

• Variety of goods and services• High consumer satisfaction

• Freedom to chose career, spend their income how they wish, own private property, take risks and earn profits

Define circular flow of economic activity

Economic model that pictures income as flowing continuously between

businesses and consumers

Market

Disadvantages:• Doesn’t provide for basic needs of all

members• Doesn’t provide enough services

people highly value*

Market

Disadvantages:• High degree of uncertainty for workers

and business

MarketDisadvantages:

• Can fail if three conditions are not met

1. Reasonably competitive markets

2. Resources able to move from one activity to another

3. Consumer access to information to make wise choices

4. Government helps to ensure these*

Define mixed economy

System combining characteristics of more than one type of economy*

Mixed• Combines the basic elements of a pure

market economy and a command economy

Section 2

Characteristics of the American Economy*

Identify and explain the six major characteristics of a pure market

economy?

I. The six characteristics of a pure market economy

• Little or no government control• Freedom of enterprise• Freedom of choice• Private property• The profit incentive• Competition

Explain why a pure market economic system

Requires little or no government control.

Limited Role of Government

Adam Smith:• Described a system in which

government had little to do with a nations economic activity

1. Limited Role of Government• Stated that individuals left on their

own would work for their own self-interest

• They would then be guided by an “invisible hand” to use resources efficiently and thus achieve the

maximum good for society

Identify the term used to explain Smith’s version of the ideal economic system.

Capitalism

Define capitalism

Economic system in which private individuals own the factors of

production and decide how to use them within legislated limits

The government lets people and businesses make their own economic decisions w/o government constraints

Identify the other term used for pure capitalism.

Laissez-faire system

Define laissez-faire

Economic system in which the government minimizes its interference

with the economy

1. Limited Role of Government• Since the 1880’s, the role of

government-federal, state, and local-has increased

Explain how the government’s role over the economy has increased since the

1880’s

Federal agencies regulate the quality of various foods and drugs, watch over

the nation’s money, and banking system, inspect workplaces for

hazardous conditions, and guard against damage to the environment

• The federal government also uses tax revenues to provide social programs such as Social Security and Medicare• State and local government have expanded their roles in such areas as

education, job training, recreation, and care for the elderly.

Freedom of Enterprise• The American economy is also called a

free enterprise system

Define free enterprise system

Economic system in which individuals own the factors of production and

decide how to use them within legal limits; same as capitalism

Explain how the government restricts free enterprise.

Freedom of Enterprise• Zoning regulations, child-labor laws ,

hazardous waste disposal rules, and other regulations

• All limit free-enterprise to protect you

Freedom of Choice• Buyers, not sellers, make the decisions

about what should be produced

Profit Incentive• When a person invests time, know-

how, money, and other capital resources in a business, the goal is to

make a profit• The desire of profit incentive motivates

entrepreneurs to establish new business and produce new kinds of goods and

servicesw

Private Property• One of the most important characteristics of capitalism

Define private property

Whatever is owned by individuals rather than by government

Define profit

Money left after all the costs of production-wages, rents, interests, and

taxes-have been paid

Define profit incentive

Desire to make a money that motivates people to produce and sell goods and

services

Describe the rights of property.

• The rights of humans to risk investment, own and produce assets,

learn new ways of producing, and enjoy the benefits if these choices

result in profits

Competition• Encouraged by the lure of profits

• Leads to an efficient use of resources• Forces businesses to keep their production costs as low as possible

• For competition to exist, barriers to enter and exit from industries must be

weak

Define competition

Rivalry among producers or sellers of similar goods and services to win more

business

Section 3

The Goals of the Nation

Identify the goals of free enterprise.

Goals of free enterprise• Economic Freedom

• Economic Efficiency• Economic Equity

• Economic Security• Economic Stability• Economic Growth

Economic Freedom• Goal: To allow each member of

society to make choices

Which country has the highest degree of economic freedom?

United States of America

Identify the consequences of economic freedom.

If a business fails, the government won’t help out

Economic Efficiency• Wise use of available resources so that

costs do not exceed benefits• We must always be watchful that the

costs of our economic actions do not exceed the benefits

Economic Equity• The attempt to balance an economic policy so that everyone benefits faily

Economic Security• Security is provided through a number

of government social programs

Economic Stability• Goal: To reduce the extreme ups and

downs in the standard of living• The standard of living is measured by

the average value of goods and services used by the average citizen

during a given period of time

Define standard of living

The material well-being of an individual, group, or nation measured by how well

their necessities and luxuries are satisfied

Economic Growth• Expansion of the economy to produce

more goods, jobs, and wealth

What is required to for a nation to achieve economic goals?

Trade-offs

Explain the responsibilities associated with a well-functioning free enterprise

system.

Individual responsibilities • Ability to support yourself and your

family• Responsibility to use your education in

a reasonable manner that helps you become a productive member of the

free enterprise system

Individual responsibilities• Individuals have the responsibility of

electing responsible government officials