Chapter 2: Economic Systems and Tools

1. Chapter 2: Economic Systems and Tools Section 2.1 Economic Questions and Systems (33)

2. The Three Economic Questions All economies must answer 3 questions : • What __________ and _____________ will be produced? • _____________ will they be produced? • __________________ will they be produced?

3. The Three Economic Questions (continued) Some standards used to distinguish among economic systems are: • __________ owns the resources. • What decision-making process is used to _________________resources and products. • What types of ____________________ guide economic decision makers.

4. Pure Market Economy • In a pure market economy _____________ firms account for all production. • There is no _____________ involvement at all. • Features of this economic system include. • the _______________ ownership of all resources, and • the coordination of economic activity based on the prices generated in free, _________________ markets. • Any ___________________ derived from selling resources goes exclusively to the resource owners.

5. The Invisible Hand of Markets • According to __________ ____________market forces coordinate production as if by an “invisible hand.” • Smith argued that although each individual pursues his or her self-interest the “invisible hand” of market competition promotes the _________________________. • _____________________ choices in competitive markets answer the questions what, how and for whom.

6. Problems with Pure Market Economies • The most notable market failures include: • Difficulty enforcing ________________ rights • In a pure market economy, there is no government, so there is no central authority to ________________ property rights, enforce contracts, and otherwise ensure that the rules of the game are followed • Some people have few ________________ to sell • Because markets do not guarantee even a minimum level of _____________________, some people would have difficulty surviving

7. Problems with Pure Market Economies (cont’d) • Some firms try to ___________________ markets • Despite the theory of the “invisible hand” some producers may try to monopolize the market by either unfairly driving out ________________ or by conspiring with competitors to increase prices • No __________________ goods • _________________________ firms do not produce so-called public goods such as national defense.

8. Problems with Pure Market Economies (cont’d) • Externalities • ______________________ reflect the benefits to buyers and the cost to sellers • Some production and consumption affect ____________ – those not directly involved • Private markets _______________ to account for externalities • Because of this type of market failure, even market economies allow a role for _________________________.

9. Pure Command Economy • In a pure command economy, all resources are _____________________________and production is coordinated by the central plans of government ________________. • In theory, there is public, or __________________, ownership of all resources. • A command economy is sometimes called _________________. • ______________________ answer the 3 economic questions by spelling out how many missiles, how many homes and how much bread to produce. • Central planners also decide ________________________ these goods and who should get them.

10. Problems with Command Economies • __________________________get low priority • ___________________ freedom of choice. • Central planning can be _________________ – the former Soviet Union had a command economy. • Resources owned by the central authority are sometimes wasted – nobody has an _______________________ to see that resources are employed in their highest-valued use. • Environmental Damage • in theory command economy should take better care of the environment than a market economy – common good; directors of state enterprises are often more concerned with meeting ____________________ goals set by central planners

11. Mixed Transitional and Traditional Economies • No country represents either a market economy or a command economy in its pure sense! • Most economies now mix central planning with competitive markets and are called ______________________________.

12. Mixed Economy • The United States is a mixed economy - it is also considered a ________________ economy because markets play a relatively large role • Government accounts for about ________________ of all U.S. economic activity • Government also _______________________ the U.S. private sector in a variety of ways • Federal bodies regulate workplace safety, environmental quality, competition in markets, and many other activities.

13. Transitional Economy An economic system in the process of shifting from __________________ planning to _________________ markets. • More than two dozen countries are transitional economies • The transition involves converting government enterprises into private enterprises – a process called ____________________.

14. Traditional Economy • An economic systems shaped largely by ___________________or religion; examples: • India - _______________ system restricts occupational choice • Charging interest is __________________ under Islamic law • ________________ relations also play significant roles in organizing and coordinating economic activity