Lecture Outlines

OUTLINE -- CHAPTER 2
The Economizing Problem: Making Choices

MAKING CHOICES - continued

BRIEF OUTLINE: The Necessity of Choice / Making Choices

IV. How Countries Make Economic Choices: Pure Capitalism and the Market System (The Market and the 5 Es)

A. Introduction
  • Economic Systems
    • A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem;
    • A method of organizing an economy

     

  • Two main types:
    • Command Economy or socialism
    • Market Economy or Capitalism

       

    • Economic systems are ways that countries answer the 5 fundamental questions (p. 34-36):
      1. What will be produced?
      2. How will goods and services be produced?
      3. Who will get the output?
      4. How will the system accommodate change?
      5. How will the system promote progress?

       

    • Economic Systems:
      • There are no PURE command economies
      • There are no PURE market economies
      • Instead there is a continuum of different characteristics

       

      • All over the world countries are changing their economies from command economies to market economies

       

    • Economic Systems: Characteristics
      • who owns
      • who decides
    • Types of Economic Systems
      • Pure Capitalism
        • also called:
          • market economy
          • competition
          • free enterprise
          • laissez-faire capitalism
      • Command Economy
        • also called
          • socialism
          • state-run economy
          • centrally planned economy
          • communism
        • Examples:
          • North Korea
          • Cuba,
          • Turkmenistan
          • Myanmar
          • Belarus
          • Laos
          • Libya
          • Iran
          • Iraq (until 2003)
    • All economic systems are Mixed Systems

 

TYPE OF SYSTEM
WHO OWNS?
WHO DECIDES?

Pure Capitalism:
private ownership
the market system

Command Economy:
government ownership
centralized (or gov't) decision-making

Mixed Economy
some private and some government
some private and some government

B. Capitalist Ideology

  • Basic Characteristics:

    CLASS:

    TEXTBOOK:
    1. private property
    2. freedom of enterprise and choice
    3. role of self interest
    4. competition
    5. markets and prices
    6. limited role for government
    1. private property
    2. freedom of enterprise and choice
    3. role of self interest
    4. competition
    5. markets and prices
    6. technology and capital goods
    7. specialization
    8. use of money
    active, but limited government

1. private property

2. markets and prices

  • prices GUIDE resources
    • pickups driving to Florida with plywood
    • consumer sovereignty and dollar votes
  • prices RATION goods and services
    • high prices after a hurricane encourage people to conserve
  • markets and prices affect allocative efficiency

    Quick Quiz:

    TO DECIDE HOW TO USE ITS LIMITED RESOURCES TO SATISFY HUMAN WANTS PURE CAPITALISM RELIES ON:
    A. CENTRAL PLANNING
    B. FREE TRADE
    C. A PRICE SYSTEM
    D. FULL EMPLOYMENT

3. role of self interest

  • Introduction: would you rather have government or private business . . . . ? WHY?
    • gas station near a desert
    • your e-mail service
    • 24 hour gas stations
    • other

 

  • Self interest is a powerful force and IF THERE IS COMPETITION IN AN ECONOMY it will result in improving the social good as if there is some "invisible hand" guiding their decisions.
    • "greed" and productive efficiency
    • "greed" and allocative efficiency
    • "greed" and economic growth

4. freedom of enterprise and choice

  • definitions
    • Freedom of enterprise means that entrepreneurs and businesses have the freedom to obtain and use resources, to produce products of their choice, and to sell these products in the markets of their choice.

     

    • Freedom of choice means:
      • Owners of property and money resources can use resources as they choose.
      • Workers can choose the training, occupations, and job of their choice.
      • Consumers are free to spend their income in such a way as to best satisfy their wants (consumer sovereignty).

       

  • provides the means for "greedy" people to help the economy achieve allocative and productive efficiency and economic growth

5. competition = capitalism

  • what is competition?
    • 1. Large numbers of sellers mean that no single producer or seller can control the price or market supply.

      2. Large number of buyers means that no single consumer or employer can control the price or market demand.

      3. Depending upon market conditions, producers can enter or leave industry easily.

  • competition is the "invisible hand"
    • plywood after a hurricane
    • monopolies and inefficiency

6. limited role for government

  • What IS the economic role for government? (chapter 5)
    • education?
    • highways?
    • defense
    • health care?
    • restaurants?
    • making skis?

     

  • Whenever the government does something we should as "WHY?"
    • Why should we ask "WHY?"
    • Why not let the government do everything?
    • Why not let private businesses do everything?

     

  • Economic goals: 5 Es

 

  • Problems with capitalism:
    • at times even market economies achieve allocative INefficiency:
      • overproduction (too much produced) of goods with negative externalities
      • underproduction (too little produced) of goods with positive externalities
      • tendency for business to increase monopoly power and produce less to increase profits
    • macroeconomic instability (periods of high unemployment and periods of high inflation)
    • no mechanism to guarantee equity

 

C. The Market System at Work

1. The Market and the 5Es
a. Economic Growth
(1) Define
(2) Economic Growth and the characteristics of Capitalism
(a) private property
(s) self interest
(c) freedom of enterprise and choice

(3) market economies tend to have faster growth rates than do command economies

b. Allocative Efficiency: Producing what consumers want

(1) The role of self interest in capitalism provides INCENTIVES to be allocatively efficient.
  • more profits = produce more (industry expands)
  • losses = produce less (industry shrinks)
  • Profits, and losses, are important

(2) Capitalism's use of the market (supply and demand - Ch. 3) provides a MEANS to achieve allocative efficiency

  • consumer sovereignty and "dollar votes"

(3) Capitalism tends to achieves allocative efficiency (this is why we will study supply and demand in chapter 3)

c. Productive Efficiency: Producing at a minimum cost

(1) The role of self interest (greed?) in capitalism provides INCENTIVES to be productively efficient.
(a) profits = total revenues - total cost
(b) minimizing costs means more profits
(c) minimizing costs is productive efficiency

(2) Capitalism tends to achieve productive efficiency

d. Equity

  • Capitalism does not have a mechanism to assure EQUITY. This may be a role of government (ch. 5)

e. Full Employment

  • Economists disagree over whether capitalism will guarantee FULL EMPLOYMENT.
  • studied in macroeconomics

2. Summary:

a. The move toward capitalism has resulted in high rates of ECONOMIC GROWTH in many countries. Profits, private property, and freedom of enterprise and choice promote growth

b. The price mechanism (supply and demand) and the role of self interest provides for an ALLOCATIVELY EFFICIENT use of resources

c. Capitalism provides the incentives (profit) for a PRODUCTIVELY EFFICIENT use of resources

d. Capitalism does not have a mechanism to assure EQUITY. This may be a role of government

e. Economists disagree over whether capitalism will guarantee FULL EMPLOYMENT.

  • Some say yes, and if there is unemployment it is usually caused by government interference
  • Some say no, and at times government involvement is needed to move the economy towards full employment

Pure Capitalism and the Market System:
The Market and the 5 Es

Characteristics of a Market Economy (Capitalism)

A. private property
B. markets and prices
C. role of self interest: incentives
D. freedom of enterprise and choice
E. competition
1. large numbers
2. free entry and exit
3. produce standardized products

F. limited role for government

The Market and the 5Es

1. Economic Growth
Capitalist economies tend to have more rapid rates of growth

2. Allocative Efficiency: Producing what consumers want

a. Capitalism and incentives and means
(1) more profits = produce more

(2) losses = produce less

(3) consumer sovereignty and "dollar votes"

b. Capitalism tends to achieves allocative efficiency

3. Productive Efficiency: Producing at a minimum cost

a. Capitalism and incentives
(1) profits = total revenues - total cost

(2) minimizing costs means more profits

b. Capitalism tends to achieve productive efficiency

4. Equity

There is no characteristic of capitalism which will guarantee equity

Often, the government gets involved to help achieve equity

5. Full Employment

Economists disagree over whether capitalism will result in full employment
  • Some say yes, and if there is unemployment it is usually caused by government interference
  • Some say no, and at times government involvement is needed to move the economy towards full employment

 

V. Capitalism and the Five Fundamental Questions

A. Introduction
1. The five fundamental questions must be answered by all economic systems.

2. The five fundamental questions are:

a. What goods and services will to be produced?
b. How will the goods and services be produced?
c. Who will get the output?
d. How will the system accommodate change?
e. How will the system promote progress?

B. What will be produced? (Allocative Efficiency)

1. In order to be profitable, businesses must respond to consumers' (individuals, other businesses, and the government) wants and desires.

2. Consumer Sovereignty and "dollar votes"

 

C. How will the goods and services be produced? (Productive Efficiency)

1. The market system encourages and rewards those producers who are achieving least-cost production.

2. The most productively efficient technique will be the one that produces a given amount of output with the smallest input of limited resources.

D. Who will get the output? (Equity)

1. determined by how the income is distributed

2. Products go to those who are willing and able to pay for them.

3. The productivity of the resources, the relative supply of particular resources, and the ownership of the resources will determine the income of individuals and households.

4. The resulting distribution of income may not be the most equitable (fair).

E. How will the system accommodate change?

1. Markets are dynamic - what is efficient today may not be efficient tomorrow as tastes, technology, and resource supplies change.

2. Prices help signal those changes and the market will respond. This guiding function of prices is essential to a well-functioning market system.

3. In the absence of such signals, government or some similar institution would have to decide where resources are allocated, but without knowing what people in society want. the result would most likely be allocatively inefficient.

F. How will the system promote progress?

1. The market system promotes technological improvements and capital accumulation (economic growth).

2. An entrepreneur or firm that introduces a popular new product will be rewarded with increased revenue and profits. (allocative efficiency)

3. New technologies that reduce production costs, and thus product price, will spread throughout the industry as a result of competition. (economic growth)

4. Creative destruction occurs when new products and production methods destroy the market positions of firms that are not able or willing to adjust. NOTE: this is good for society.

VI. The Circular Flow Model of Capitalism

 

 

The Circular Flow Model

The flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firms to households and from households to firms.

A. Two Markets
1. product market

A market in which products are sold by firms and bought by households.

a. how much to buy
b. how much to produce

2. resource market

A market in which households sell and firms buy resources or the services of resources.

a. how many to hire
b. how much we earn

B. Two Flows

1. real flow
2. money flow

C. Reversal of Roles
D. Limitations

E. Diagram

 

 

Lecture Outlines