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Micro - Economic Systems

The document discusses fundamental economic questions that every society must answer, which shape its economic system. It outlines three main types of economic systems: Command Economy, Capitalism, and Mixed Economy, detailing their advantages and disadvantages. Additionally, it explains how the free market regulates itself through competition and self-interest, ultimately leading to efficient production that meets consumer demands.

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julie2008wu
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6 views12 pages

Micro - Economic Systems

The document discusses fundamental economic questions that every society must answer, which shape its economic system. It outlines three main types of economic systems: Command Economy, Capitalism, and Mixed Economy, detailing their advantages and disadvantages. Additionally, it explains how the free market regulates itself through competition and self-interest, ultimately leading to efficient production that meets consumer demands.

Uploaded by

julie2008wu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Economic Systems

Economic Systems
• Fundamental economic questions: Every society must answer these
three questions
• What goods and services should be produced?
• How should these goods and services be produced?
• Who gets What?

• The way these questions are answered determines the economic


system

• An economic system is the method used by a society to produce and


distribute goods and services
Three Economic Systems
• The Command Economy (Centrally Planned) – Central Government
dictates what will or will not be produced. E.g. North Korea, Cuba,
former Soviet Union – both partial command economies
• Advantages:
• Wages can be set, so no lower class; equitable distribution
• Great job security; Government does not go out of business
• Prices of items can be set to encourage / discourage a particular behavior. E.g.
Education, Alcoholism

• Disadvantages:
• No incentive to work hard or innovate or take risk; lack of entrepreneurs
• Lack of competition keeps quality of goods poor
• Mistake-prone due to scale
Economic Systems – contd.
• Capitalism (Free Market System): Supply and demand determine prices; free
markets. Consumers (demand), not government, determine how much of
each item will be produced
• Little / no government involvement in the economy
• Laissez Faire = Let it be
• Individuals answer three economic questions NOT Government
• Advantages:
• Allocative efficiency; no government intervention required
• Decentralized decision making of price
• Efficiency over equitable distribution – opportunity to make profit gives
people incentive to produce quality items efficiently
• Disadvantages:
• Lack of authority to mediate and settle disputes
• Competitive markets could break down
Example of how Free Market regulates itself
If students want AP courses and only one institute is offering a course…
Other institutes have the INCENTIVE to start offering courses to earn
PROFIT.
This leads to more COMPETITION…. More institutes come up and more
teachers are hired based on their skill and experience
Which means lower prices, better quality teaching and more content
variety.
We produce the goods and services that society wants because
“resources follow profits.”

The End Result: Most efficient production of the goods that consumers want,
produced at the lowest prices and the highest quality.
The Invisible Hand
• Society’s goals will be met as individuals seek their own self-interest
• Example: Society wants faster and efficient computers
• Profit-seeking producers will make more
• Competition between firms results in low prices, high quality and greater efficiency.
• The government doesn’t need to get involved because the needs of society are
automatically met.
• Competition and self-interest act as an Invisible Hand that regulates the
free market.
Allocative efficiency is a state of economy in which production represents consumer
preferences. Each good is produced up to the point until last unit produced provides
a marginal benefit to consumer equal to marginal cost of production
Economic systems – contd.
• Mixed Economy: Blend of command and capitalism; most of
resources are owned by individuals and households
• Most practical – most, if not all, countries use this economy model
• E.g. US – Capitalism is emphasized but government commands are used when
free markets break down
Which
system is
the best?
North Korea and South Korea at night
Circular Flow Diagram
Circular Flow Diagram
The adjoining figure shows:
• How resources are used to produce goods
and services

• How these goods and services are


distributed

• Individuals and households sell their


resources to firms that use the resources to
produce goods and services

• Individuals and households use the


proceeds from sale of their resources to
purchase the output of firms

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