Chapter 2

• Economic system


  A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem; a method of organizing an economy, of which the market system and the command system are the two general types.
• The four major role players in any economic system

  Households, business enterprise, government, foreign sector
• Resources flow from

  households to businesses through the resource market
• Products flow from

  Firms to households through the product market
• Households receive incomes from firms through the resource market
• Businesses receive revenue from households (expenditure) through the product market
• How are governments part of the flow between markets

  Taxes and services to and from services and firms
• Laissez-faire capitalism or pure capitalism


  The gov role is limited to protecting private property and establishing a legal environment in which contracts are enforced and people interact in markets to buy and sell goods, services and resources
• Market


  Any institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of a particular good or service.
• Command system


  A  method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; command economy; communism. Gov has complete control over economic activity
• Market system or mixed economy


  All the product and resource markets of a market economy and the relationships among them; a method that allows the prices determined in those markets to allocate the economy’s scarce resources and to communicate and coordinate the decisions made by consumers, firms and resource suppliers.
• What does the central planning board do in command systems?

  Determines production goals for enterprises, specifies resources allocated to each enterprise to reach its production goals. The division of output between capital and consumer goods is centrally decided and capital goods are allocated among industries based on the planning board's long term priorities
• Problems with the command system

  coordination and incentive
• The coordination problem

  Central planners had to coordinate millions of individual decisions by consumers, resource suppliers and business and establish realistic production targets. The failure of a single industry to meet its output targets caused a chain reaction of repercussions.
• The incentive problem


  When central planners misjudged, shortages and surpluses arose. But as managers were rewarded for meeting assigned production goals, they had incentive to adjust. No fluctuations in price or profitability indicated more or less product was needed
• Specialisation


  The use of the resources of an individual, a firm, a region or a nation to concentrate production on one or a small number of goods and services.
• Division of labor


  The separation of the work required to produce a product into a number of different tasks that are performed by different workers; specialization of workers.
• Private property in the command system

  Gov owned
• Freedom of enterprise and choice in the command system

  Government makes the choice of when, what and who
• Self interest in the command system


  No incentive to work or choose for own interest
• Competition in the command system


  None
• Market and prices in the command system


  Gov decides
• Tech and capital goods 


  Central gov decides on what and how
• Specialisation in the command system


  Gov decides where and what
• Division of labor in the command system

  Gov controlled
• Gov intervention in the market in the command system

  Full control
• Five fundamental questions

  Solved by central gov decisions
• Private property in LF market

  Mainly privately owned
• Freedom of enterprise and choice in LF market

  Freedom to make choices and start enterprises
• Self interest in LF market 


  Completely self interest driven
• Competition in LF market

  Full market competition between buyers and sellers
• Market and prices in LF market 


  Choices are freely driven by the price mechanism
• Technology and capital goods in LF market

  Constant drive by individuals and firms to improve tech and obtain more capital goods
• Specialisation in LF market

  Determined by pricing mechanism
• Division of labour in LF market 


  Labour market-driven based on individual choices
• Gov intervention in markets in LF market

  Very limited gov control
• Five fundamental questions

  Solved by individuals and firms driven by price mechanism
• A market system allows for the private ownership of capital  , communicates through prices , and coordinates economic activity through markets
• A key driver of the market system is that

  Participants act in their own self interest
• Private property rights are important because 


  when coupled with the freedom to negotiate contracts, they allow individuals and businesses to use resources as they see fit