Notes
Three questions, many systems
- Every society must decide what, how and for whom to produce. An economic system is its way of answering.
- Societies pursue goals such as efficiency, freedom, equity, security, growth, price stability and full employment. Goals can conflict, and people weigh them differently.
Types of economies
- Traditional: custom decides. Stable but slow to change.
- Command: the government owns most resources and plans production, as in the Soviet Union and North Korea. Planners lack price signals, which often led to shortages and weak incentives.
- Market: individuals and firms decide through voluntary exchange. Prices are signals; self-interest, profit and competition drive production. Adam Smith's "invisible hand" (1776).
- Mixed: all modern economies blend markets and government. Countries in transition, such as China after 1978 and Russia after 1991, moved toward markets through reform and privatization.
The circular flow
- Households sell factors of production to firms in the factor market and buy goods and services in the product market. Money flows one way; goods and resources flow the other. Government collects taxes, buys goods and makes transfer payments.
Free enterprise
- U.S. features: private property, profit motive, voluntary exchange, competition, consumer sovereignty.
- Government protects property and contracts, keeps competition fair, provides public goods and a safety net, and works to stabilize the economy. How far these roles should go is debated.
Topics in this unit
Each topic has its own short notes and practice.
Practice
Planners often set prices below what buyers would pay and produce too little, causing shortages.
Rent is a payment for a factor of production, made in the factor (resource) market.
Smith's "invisible hand" links self-interest and competition to the public good.
Consumers and producers lose the freedom to decide what is produced.
It blends market decisions with government provision of some goods and services.
Privatization and new competition move an economy toward the market end of the continuum.
Free response
Write your answer first, then open the scoring guide.
Free-response question
Economies answer the three basic economic questions in different ways.
(a) Explain how a command economy and a market economy each answer the question "What goods and services should be produced?"
Show the answer and scoring guide
In a command economy, government planners decide what to produce, often setting output targets for each industry. In a market economy, consumers decide through their purchases; businesses seeking profit make the goods people are willing to buy, guided by prices.
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(b) Describe ONE advantage and ONE disadvantage of a market economy.
Show the answer and scoring guide
Advantage: it is efficient and offers wide choice and innovation, because competition rewards firms that meet consumer wants at low cost. Disadvantage: it may not provide public goods such as national defense, and it can leave people who cannot work without income, leading to large inequality.
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(c) Using the circular flow model, trace what happens to the money a household spends on a new bicycle.
Show the answer and scoring guide
The household pays a bike shop in the product market, and the bicycle flows to the household. The shop uses the money to pay for factors of production in the factor market, such as wages to its workers and rent for its store. Those payments return to households as income, which they can spend again.
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