Unit 2 PPT Updated
Unit 2 PPT Updated
What is an economic system?
The method used by a society to
produce and distribute goods and
The Three Questions that Determine
a Societies Economic System
Because ALL economic resources are
scarce, every society must answer three
What goods and services should be produced?
How should these goods and services be
Who consumes these goods and services?
Societies answer the three economic questions
based on their goals and values.
Making the most of resources
Freedom from government intervention in
the production and distribution of goods
Assurance a safety net will protect
individuals in times of economic disaster
Fair distribution of wealth
Innovation leads to economic growth, and
economic growth leads to a higher
standard of living.
Environmental protection, variety
An economic system is the method used by a society
to produce and distribute goods and services.
Traditional economies rely
on habit, custom, or ritual to
decide what to produce,
In a market economy
how to produce it, and to
economic decisions are
whom to distribute it.
made by individuals and
are based on exchange, or
In a centrally planned
economy the central
government makes all
decisions about the
consumption of goods and
Mixed economies are
systems that combine the
free market with limited
Comparing Economic Systems
Who answers the 3 ?’s
Individuals with some
The Free Market System (a.k.a. Capitalism)
Why do markets exist?
Markets exist because none of us produces
all the goods and services we require to satisfy
our needs and wants.
A market is an arrangement that allows
buyers and sellers to exchange goods and
Specialization is the concentration of the
productive efforts of individuals and firms on a
limited number of activities.
a free market
business firms use
own the factors
Circular Flow Diagram of a Market Economy
“The Father of Economics” Adam Smith (1723-90)
“The Wealth of Nations”
10 years to write/5 volumes
Established Economics as its
Adam Smith and the Invisible Hand
every transaction, the buyer and seller
consider only their self-interest, or their
own personal gain. Self-interest is the
motivating force in the free market.
Producers in a free market struggle for the
dollars of consumers. This is known as
competition, and is the regulating force
of the free market.
The interaction of buyers and sellers,
motivated by self-interest and regulated
by competition, all happens without a
central plan. This phenomenon is called
“the invisible hand of the marketplace.”
Advantages of the Free Market
Growth and Innovation
Variety of Goods and Services
Centrally Planned Economies
Definition ~The government, or a central authority,
controls the factors of production.
Organization of Centrally Planned Societies
Modern Day Forms of Central Planning:
Socialism~ a social and political philosophy based on
the belief that democratic means should be used to
distribute wealth evenly throughout a society.
Communism~ a political system characterized by a
centrally planned economy with all economic and
political power resting in the hands of the
government. Communist governments are
authoritarian in nature.
Communist Theory (Today, Marxism):
Karl Marx (1818-1883)
philosopher, political economist and historian
Developed radical approach to understanding and coping
with the problems that occurred in free market systems,
namely the Industrial Revolution
Published the Communist Manifesto in 1848 with Engels
He argued that history is a series of class struggles between
the rich capitalists and the working class.
He believed that eventually workers needed to unite and
revolt against the capitalists. This revolution would then
breed a classless society.
Philosophy Becomes Reality: The Soviet Union
In 1917, the ideas
proposed by Marx
would become a
Revolution, led by
Lenin, would result
in a centrally
The Soviet Experiment
of production were all controlled by the state.
The best resources were allocated to the armed
forces, space program, and production of capital
Government committees decided the quantity,
process and distribution of all products.
The government created large state-owned farms
and collectives to produce all agricultural products.
There was little incentive to produce, and the Soviet
Union saw a decline in the production of agricultural
Advantages and Disadvantages of
Centrally Planned Economies
1. Public goods and services
provided by the state (i.e.
2. Wasteful competition is
3. Peaceful labor conditions
4. Welfare of citizens is the
primary goal of the state
5. Business cannot act against
the interest of the people
1. Poor-quality goods and
2. Failure to meet set ideals/
3. Lack of incentive to work
4. Lack of innovation
5. Expensive and inflexible
6. Sacrifice of individual
freedoms for society
modern economies mix features of both
systems (centrally planned and free market).
An economic system that permits the conduct
of business with minimal government
intervention is called free enterprise.
This is the system that exists in the United
States and most industrialized nations
throughout the world.
How do mixed economies differ? For example
consider the United States and France.
American Free Enterprise
(Freedom vs. Protection)
Tradition of Free Enterprise
Americans have favored economic
freedom over economic regulation, but
we still expect the government to protect
us from the problems that can exist in free
All Americans act to decide when the
benefits of government protection
outweigh the drawbacks to free
The Role of the American Consumer
The Role of Government
1. Protect the Public Interest
2. Provide Information
3. Promote Growth and Stability
Gross Domestic Product
Gross Domestic Product
main indicator used to determine
overall health of the economy is gross
domestic product (GDP) which is the
dollar value of all final goods and services
produced within a country’s borders in a
This will allow them to better determine
upcoming business cycles to determine
prosperity, recession or depression.
Limitation of GDP
Quality of life
GDP vs. GNP
Annual income earned by
US owned firms and citizens.
Types of Unemployment
Frictional Unemployment- Occurs when people change jobs,
get laid off from their current jobs, take some time to find the
right job after they finish their schooling, or take time off from
working for a variety of other reasons
Structural Unemployment- Occurs when workers' skills do not
match the jobs that are available. Technological advances
are one cause of structural unemployment
Seasonal Unemployment- Occurs when industries slow or shut
down for a season or make seasonal shifts in their production
Cyclical Unemployment- Unemployment that rises during
economic downturns and falls when the economy improves
A nation’s unemployment rate is an important
indicator of the health of the economy.
The Bureau of Labor Statistics polls a sample
of the population to determine how many
people are employed and unemployed.
The unemployment rate is the percentage of
the nation’s labor force that is unemployed.
Getting Everyone To Work!!!!
generally agree that in an
economy that is working properly, an
unemployment rate of around 4 to 6 percent is
Sometimes people are underemployed, that is
working a job for which they are overqualified, or working part-time when they
desire full-time work.
Discouraged workers are people who want a
job, but have given up looking for one.
Full employment is the level of employment reached when there is
no cyclical unemployment.
is a general
increase in prices.
Purchasing power, the
ability to purchase goods
and services, is decreased
by rising prices.
To Market, To Market
A price index is a measurement that shows how the
average price of a standard group of goods changes
consumer price index (CPI) is computed each
month by the Bureau of Labor Statistics.
The CPI is determined by measuring the price of a
standard group of goods meant to represent the
typical “market basket” of an urban consumer.
There are over two hundred categories of products that are included in the
basket. These categories fall under 8 major groups:
FOOD AND BEVERAGES
EDUCATION AND COMMUNICATION
OTHER GOODS AND SERVICES
Too much $ in the economy
Demand exceeds supply
Increased input costs for the
Impact of Inflation
High inflation is a major economic problem,
especially when inflation rates change
greatly from year to year. The three main
Reduced Purchasing Power
Erosion of Interest Income
Erosion of Wages/Income
The Poverty Problem
Although the free market is the most
successful economic system at
producing wealth—distribution is HIGHLY
The poverty threshold is an income
level below what is needed to support
families or households. What is the
POVERTY...THE FORGOTTEN STATE
Who does the government
provide a safety net for?
o Welfare is a general term that refers to
government aid to the poor
o 1930’s- Under Roosevelt the
government began welfare programs
to reduce the impact of the Great
o 1960’s- Lyndon Johnson launched the
“War on Poverty”
o 1990’s- Clinton transformed welfare
program to Temporary Assistance to
Needy Families (TANF)
Type of Program
Direct payment of cash to
Goods and services for free
or reduced prices
Health insurance to those
that cannot provide it for
Federal, state, and local
government all provide
money for the poor and
disabled to ensure all