2017-11-30
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Three Economic Questions
All economies must answer these three questions:
1. What goods and services will be produced?
2. How will they be produced?
3. For whom will they be produced?
An economic system is the set of mechanisms and institutions that resolves the what, how, and for whom questions.
Some standards used to distinguish among economic systems are:
„ Who owns the resources?
„ What decision-making process is used to allocate resources and products?
„ What types of incentives guide economic decision makers?
Pure Market Economy
§ All resources are privately owned
§ Coordination of economic activity is based on the prices generated in free, competitive markets
§ Any income derived from selling resources goes exclusively to each resource owner
According to economist Adam Smith (1723–1790), market forces coordinate production as if by an “invisible hand.”
Problems with Pure Market Economies
ü Difficulty enforcing property rights
ü Some people have few resources to sell
ü Some firms try to monopolize markets
ü No public goods
ü Externalities
Pure Centrally Planned Economy
§ All resources government-owned
§ Production coordinated by the central plans of government
§ Sometimes called communism
§ Use visible central planners
Problems with Centrally Planned Economies
ü Consumers get low priority
ü Little freedom of choice
ü Central planning can be inefficient
ü Resources owned by the state are sometimes wasted
ü Environmental damage
Mixed Economy
§ United States is a mixed economy
§ Also considered a market economy
§ Government regulates the private sector in a variety of ways.
Transitional Economy
§ A transitional economy is in the process of shifting orientation from central planning to competitive markets.
§ It involves converting state-owned enterprises into private enterprises—privatization.
§ The transition now under way will shape economies for decades to come.
Traditional Economy
§ A traditional economy is shaped largely by custom or religion.
§ Family relations also play significant roles in economic activity.
Production Possibilities Frontier
