Economic Systems

AS Economics Unit 1
ECONOMIC SYSTEMS
BASIC ECONOMIC DECISIONS

No two economies are organized in
exactly the same way, but all have
to solve three fundamental
problems:
What should be produced
in the economy?
What quantities of food, mobile
phones or banking services should
be produced by the economy?
How many trees need to be felled
to meet the demand for pulp for
newspapers and magazines?
Should we spend extra money on
national defence or should more
resources be devoted to health care
and education?

How should production be
organised?
Should a firm use labour or machinery to
produce their goods?
How many workers should be employed?
Should production take place in London
or Newcastle or in the UK or Malaysia?
Why has the Vaux Brewery closed down
in Sunderland?
These are all examples of important
production decisions.
For whom should
production take place?
Should everybody be entitled to an
identical share of production, or
should some receive more than
others?
There are large-scale inequalities in
people's living standards.
Indeed the gap between rich and
poor has widened considerably over
the last twenty years.



TRADITIONAL OR SUBSISTENCE
ECONOMIES


TRADITIONAL OR
SUBSISTENCE ECONOMIES

There is little specialisation and trade within the
economy and with other countries
The productivity of workers tends to be low
leading to low incomes and a poor standard of
living
People tend to live in family groups, and grow
most of their own food, make their own houses,
gather their own fuel and provide their own
leisure activities i.e. to a great extent they are
self-sufficient
Few goods and are marketed and command a
price or value - there is little surplus production
to export
Free market Economies
FREE MARKET ECONOMIES/
MARKET ECONOMIES/
CAPITALIST ECONOMIES
A free market economy is one
where economic decisions are made
through the free market
mechanism.
The forces of market demand and
supply, without any government
intervention, determine how
resources are allocated.
This is known as the working of the
price mechanism.
THE INTERDEPENDENCE OF
MARKETS - GOODS MARKET.
Demand for the good rises
This creates a shortage
This causes the price of the good to rise.
This eliminates the shortage by choking
off some of the demand and encouraging
firms to produce more.

THE INTERDEPENDENCE OF MARKETS
- FACTOR MARKET
The increased supply of the good causes
an increase in the demand for factors of
production (inputs) used in making it.
This causes a shortage of those inputs
This causes their prices to rise.
This eliminates their shortage by choking
off some of the demand and
encouraging the suppliers of inputs to
supply more.

The price mechanism: the
effect of a rise in demand
Goods market
D

Shortage
Dg>Sg
Pg
Sg
Dg
Until
Dg=Sg
Factor market
Sg Di
Shortage
Di>Si
Pi
Si
Di
Advantages of a free
market economy
It regulates itself.
There is no need for costly and complex bureaucracies.
The economy can respond quickly to changing demand and supply.
Competition between firms keeps prices down and acts as incentive
to become more efficient.
The more firms competing, the more responsive they will be to
consumer wishes.
The more efficiently firms combine their factors of production, the
more profit they will make.
The more efficiently workers work, the more secure their jobs will be
and the higher their wages.
The more carefully consumers decide what to buy, the greater the
value for money they will receive.
Therefore, people, in pursuing their own self-interest are helping to
minimise the problem of scarcity.
Market economies have outperformed planned economies

Disadvantages of a Free
Market Economy
What is produced is based on the vote of those
with the ability to buy rather than need.
Tends to be less equitable
External costs and benefits from production or
consumption can be ignored.
Demerit goods are produced with no
restrictions.
An insufficient quantity of public goods and
merit goods.
The poor only benefit if there is truth in the
trickle down theory, in reality this doesnt
happen sufficiently.
Erratic swings in the business cycle.

COMMAND ECONOMIES


COMMAND ECONOMIES
A command economy is one where all key economic
decisions are made by the government (or state).
The government decides what to produce how it is to be
produced and how it is to be allocated to consumers.
This involves a great deal of economy planning by the
state.
By state planning, goods and services can be produced
to satisfy the needs of all the citizens of a country, not
just those who have the money to pay for goods.
Over the last decade, many former planned
economy have attempted to bring market forces
into their economy.


GUM - Moscow
Dom Knigi - Leningrad
Advantages of a Command
Economy

Tries to be more equitable the gap is
narrower between the rich and the poor
Less wastage.
What is produced can be linked in with the
aims of the government
Resources can be used for essential items
and not frivolous ones


Disadvantages of a
Command Economy
Some are more equal than others
Tends to be slow
Tends to be bureaucratic
Wastage in unsold goods
Quality is not as important
Production methods less efficient due to
lack of competition
Product orientated rather than market
orientated
MIXED ECONOMIES
A mixed economy is a mixture of a pure free-
enterprise market economy and a command
economy.
Nearly every country in the world operates a
mixed economy although the "mix" can change.
There is a private sector and a public sector in
the economy
In recent years many command economies have
become mixed economies. Examples include
countries that were part of the former Soviet
Union.

To become a mixed
economy
The role of the market and the private sector
of the economy must be increased by:
Privatisation of state industries
De-regulation of markets promoting
increased competition through the entry of
new firms
A gradual ending of state subsidies
Encouraging foreign investment into the
economy





Totally
planned
Totally
free
North
Korea
North
Korea

Cuba
Cuba
China
China
Poland
Poland
UK
UK
USA
USA
China
Hong
Kong
China
Hong
Kong
Early 1990s
Early 2000s
The problems of economic
transition
A lack of understanding and experience of
how market forces actually work
A removal of import controls
The absence of a legal framework
Hyperinflation
An increase in inequality and
unemployment
The Success of Economic
transition
Foreign direct investment. E.g.
Volkswagen in Skoda in the Czech replublic

BMWs building a new plant in Hungary.
The Success of Economic
transition
Privatisation of manufacturing industries.

Restructuring of key industries e.g. stock
exchanges.

Financial incentives of the market system
Conclusion
No matter what the economic
system, the fundamental economic
problem of scarcity must be solved.
Every economic system faces
opportunity costs in making
decisions.