Economic Systems
Contrast in Economic Systems
Boris Yeltsin's visit to a U.S. supermarket to highlight the stark differences between the capitalist economy of the United States and the state-run economy of the Soviet Union.
Impact of Economic Policies
Yeltsin's amazement serves as a commentary on how economic systems can significantly impact the availability and variety of consumer goods, thereby affecting the quality of life for ordinary citizens.
Three Fundamental Economic Questions
Every society faces three core economic questions due to the issue of scarcity:
What to Produce?
Societies must choose which goods and services are most needed.
Example
United States of America: Conserve wilderness or use for logging?
Vanuatu: Invest in agriculture or tourism?
What will be produced?
In any economy, there are countless potential goods and services that could be produced given limited resources. This prompts the question: which wants will be satisfied and which will go unmet?
Example
In America, agribusinesses may cultivate wheat on large scales. In contrast, in France, smaller family farms are more prevalent for wheat production. This demonstrates how different societies answer this question differently.
How to Produce?
How do we address the combination of land, labor, and capital used in production?
Example
In wheat farming, should the focus be on large-scale factory farms or smaller, sustainable farms?
For Whom Will It Be Produced?
Once goods and services are produced, the next question is about distribution: who gets to consume these products?
Question
This leads to the complex issue of fairness. Who deserves what? Different societies have different methods of distribution based on social and economic ideologies.
For Whom to Produce?
Who benefits from the goods and services produced?
Example
Should healthcare be universal or available only to those who can afford it?
In essence, while the questions are universal, the answers vary depending on a society's priorities and needs.
How Will It Be Produced?
This question deals with the organization of the factors of production. Who or what determines the means of production?
Example
Consider the production of hats. In the U.S., the market usually determines whether hats are mass-produced in factories or hand-crafted. In other countries, this may not be the case.
Methods of Distribution
Goods and services are allocated through various approaches:
Ability to Pay
Most common in capitalist economies.
Equal Distribution
Practiced historically by economies like the Soviet Union, but often leads to inefficiency.
First-Come, First-Served
Used for scarce goods, like concert tickets.
Distribution According to Need
Employed by soup kitchens or public schools providing for special education students.
Warning
No method is perfect, and each has its own set of drawbacks. For instance, equal distribution might result in long waiting lines and unintended favoritism.
Economic Goals and Society's Answers
A society’s responses to the three economic questions depend on its aspirations and values. Here are some economic goals that a society may aim for:
Economic Freedom
In societies valuing economic freedom, individuals have the liberty to make their own economic choices. They can buy, sell, and own property, and sellers can set their own prices.
Tip
Economic freedom is often considered the cornerstone of capitalist societies and is believed to spur innovation and competition.
Economic Equity
This goal deals with the fair and just distribution of resources. However, the definition of "fair" varies widely among individuals and cultures.
Question
Is it equitable for CEOs to earn millions while some employees barely make minimum wage? Equity is a subjective and often contentious issue.
Economic Growth
Growth signifies an increase in the production of goods and services, leading to a rise in the standard of living.
Example
Innovations in technology have been instrumental in economic growth, introducing new products and improving living standards over time.
Economic Security
A society valuing economic security aims to protect its vulnerable members by providing essential needs like food, shelter, and health care.
Warning
The means of achieving economic security—such as public welfare systems—can be a point of contention among different groups within a society.
Economic Stability
Stability ensures that essential goods and services are consistently available, and that employment and prices are fairly predictable.
Info
Economic stability can be an important factor for long-term planning for both individuals and businesses.
Balancing Conflicting Goals
Achieving one goal might come at the expense of another. For example, taxing workers to pay for unemployment benefits might be viewed as limiting economic freedom in order to achieve economic security.
Warning
It's rare that all these goals can be fully met simultaneously. Trade-offs often have to be made, and these decisions reflect the values and priorities of a society.
The relative importance of these goals can vary between different societies and can change over time within a single society. Consequently, the ways in which a society answers the three basic economic questions are fluid and can evolve.
Economic Systems
Every society has an economic system that helps it answer the three basic economic questions. Despite the myriad of cultures and societies that have existed through history, there are essentially three fundamental types of economic systems: traditional economies, command economies, and market economies. Each of these systems answers the three basic economic questions in its own way and emphasizes different economic goals.
Traditional Economies: Ruled by Custom
The oldest type of economic system is the traditional economy, which is governed by custom and tradition.
Note
Traditional economies are often seen in indigenous communities and have been around since the time of hunter-gatherers. These economies rely heavily on custom to decide what, how, and for whom to produce.
Example
The Maasai people of East Africa primarily rely on cattle herding. Their wealth is measured in terms of livestock and children, adhering to traditions that have been in place for generations.
Command Economies: Governed by Authority
In a command economy, decisions about what, how, and for whom to produce are made by a centralized authority, usually the government.
Warning
While this system can achieve goals like equity or security more readily, it often lacks the efficiency and innovation driven by competition in market economies.
Command economies are often associated with socialism or communism, where the government owns the means of production and controls economic activities.
Opportunity Cost for high school students waiting for Food
For example, let's say that a high school student is waiting in line for food. The opportunity cost of waiting in line is the time that could have been spent studying or playing sports. The opportunity cost of studying is the time that could have been spent waiting in line for food.
Market Economies: Driven by Supply and Demand
Market economies are primarily driven by individual choices and market forces.
Tip
This system tends to be more efficient and fosters innovation but might lack in providing economic security or equity.
Balancing Goals in Different Economic Systems
Different economic systems emphasize different goals.
Traditional Economies
Emphasize stability and community well-being. - Strengths: Stability, community focus, and sustainable practices. - Weaknesses: Resistance to innovation, risk from external economic forces.
Command Economies often prioritize economic security and equity but might lack in efficiency.
Market Economies focus on efficiency and economic freedom but can fall short in security and equity.
Info
The way each system answers the three basic economic questions aligns with its prioritized economic goals. For example, a traditional economy based on hunting might prioritize sustainability and community well-being over rapid economic growth.
Flow of Money and Goods in a Market Economy
The Circular Flow Model:
Participants:
- Households: Individual persons or groups of people living together who own the factors of production.
- Firms: Organizations that utilize the factors of production to create goods or services.
- Markets:
- Product Market: Where goods and services are bought and sold.
- Factor Market: Where factors of production like land, labor, and capital are bought and sold.
- Circularity:
- Households receive money in the factor market and use it to buy goods from firms in the product market.
- Firms receive money in the product market and use it to buy factors of production from households in the factor market.
- Factor Payments: Money paid to households, either as rent, wages, interest, or dividends.
- Self-Interest: Market transactions are driven by each participant acting in their self-interest, as articulated by Adam Smith.
Capitalism, Socialism, and Communism
Capitalism
Capitalism is a free-market economic system where property and means of production are privately owned.
Historical Context:
- Originated in Europe in the 1700s.
- Fueled by the Industrial Revolution in the 1800s.
- Industrial Revolution:
- New inventions and manufacturing processes led to industrial growth.
- Gave rise to capitalists, individuals who accumulated wealth through capital like machinery, factories, and railroads.
Impact
- Positive: Improved standards of living and the availability of goods and services for many.
- Negative: Labor exploitation, inequality, long work hours, low wages.
Socialism
An economic system where property and means of production are owned by society for the benefit of all.
- Goal: Redistribution of wealth and more equal societal outcomes.
Communism
An advanced stage of socialism where all property is communally owned, and social classes disappear.
- Slogan: "From each according to his ability, to each according to his needs."
- Revolution: Marx and Engels called for workers to revolt and seize control of the means of production.
Modern Command Economies
- Origin: First successful communist revolution occurred in Russia in 1917.
- Government Structure: Authoritarian, with stringent state control over economic activities.
- Economic Planning:
- State-owned means of production.
- Central planning committees consisting of economists, experts, and officials.
- Issues:
- Often did not result in the utopian society envisioned by Marx.
- Inefficiency, lack of innovation, and human rights abuses were common. Contradiction: Despite socialist ideals, the imposition of state control often resulted in authoritarian regimes that contradicted the vision of a worker's paradise.
Flow of Goods and Money in Mixed Economies
Employment
The government is often the largest employer, hiring people in various sectors.
Purchasing Power
It is also often the largest customer, spending large amounts on goods and services from firms.
Public Services
Governments use resources to produce public goods like libraries, schools, and public transportation.
Taxes and Transfers
Governments collect taxes from households and firms and use these funds to provide public goods and services. They may also redistribute wealth via transfer payments like Social Security or unemployment benefits.
Mixed Economy Continuum
Indices: Tools like the Heritage Foundation's Index of Economic Freedom measure the degree of market freedom and government control in economies around the world.
Example
Australia: High degree of economic freedom, easy to start businesses, secure private property. North Korea: Low economic freedom, government controls all aspects of the economy, restricted foreign trade. Intermediate Cases (e.g., Japan, South Africa, France): Balanced mix of free markets and government controls, higher taxes to fund public services. China: Transitioning from a command economy but remains under significant state control.