Chapter 2 Notes

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Answering the 3 Economic Questions Every society can answer these questions. Income vs. profit Economic Goals Economic efficiency is when a society needs to assess what it needs and wants Economic freedom is being able to make your own choices. Economic security is when goods and services are available with our pay checks. Economic equality is fairness in how to divide income among the people. Economic growth needs to happen for people to have income and a high standard of living through innovation. Goals in Conflict Environmental protection, full employment, and protecting national industries are other economic goals. The goals get conflicted by decisions and trade-offs. Welfare for people, regulations may curb economic freedom. The Free Market Markets exist so that people can exchange goods and services. Adam Smith says the free market works because people act on their own self-interest. (father of capitalism****) Self-interest develops competition. Specialization leads to efficient use of land, labor and capital. Buying and selling is the use of incomes. Free Market Economy The answer to the three questions are in voluntary exchange. Participants are households and firms. Factor markets is where firms purchase the factors of production from households. Product markets is where households purchase goods and services from firms. Self-Regulating Nature of the Marketplace Self-interest is what Adam Smith in his book The Wealth of Nations,1776 stated the economy is made of countless individual transactions.

An incentive is the hope of reward or fear and the struggle among producers for dollars is competition. The invisible hand is that consumers and producers self-regulate the marketplace, not a centrally planned government. Advantages of Free Market Goals that are met: o 1. Efficiency goods and services people want are prices they are willing to pay. o 2. Freedom consumers work where they want and producers produce what they want. o 3. Growth entrepreneurs are always seeking profitable opportunities. o 4. Consumer Sovereignty the customer is always right Centrally Planned Economies These are command economies, where the government decides the 3 economic questions. Socialism is the intermediate stage between capitalism and communism Karl Marx is the father of communism stressed the conflict between labor and capital. Authoritarian governments limit freedoms and require strict obedience. Soviet Union and China The Soviet Union fought a revolution in 1917 and the communists prevailed stressed heavy industry and agriculture. The country collapsed in 1991. China fought a revolution after WW1 and in the 1970s they allowed citizens to privately own farms and firms which boosted the economy. The government still makes those decisions. Disadvantages of a centrally planned economy Command economies have trouble meeting economic efficiency, freedom, growth, and equity Mixed Economies A blend of market systems and central planning elements. Adam Smith believed that the government should be limited rather than laissez faire.

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How could governments provide for a national defense system or highways? How about public vs. private education? 5-6th Amendments life liberty and property and due process. flow of a Mixed Economy Government in the factor markets 2.7 million employees = $152 billion for their labor Government in the product markets to make roads and print money the products are purchased from private firms The government collects taxes from both households and firms.

Mixed Economies and Government Domination North Korea owns and runs everything economically. China allows privatization Hong Kong is part of China today but operates under free enterprise. In the United States federal and state laws protect private property, provide services, and promotes the general welfare. There is much economic freedom in the United States.

Economic system- the structure of methods and principles that a society uses to produce and distribute goods and services Factor payment- the income people receive in return for supplying factors of production Profit- the amount of money a business receives in excess of its expenses Safety net- a set of government programs that protect people who face unfavorable economic conditions Standard of living- level of economic prosperity Innovation- the process of bringing new methods, products, or ideas into use. Traditional economy- an economic system that relies on habit, custom, or ritual to decide the three key economic questions Market- any arrangement that allows buyers and sellers to exchange things Specialization- the concentration of the productive efforts of individuals and businesses on a limited number of activities

Free market economy- an economic system in which decisions on the three key economic questions are based on voluntary exchange in markets Household- a person or group of people living in a single residence Firm- an organization that uses resources to produce a product or service, which it then sells Factor market- the arena of exchange in which firms purchase the factors of production from households Product market- the arena of exchange in which households purchase goods and services from firms Self-interest- an individuals own personal gain Incentive- the hope of reward or fear of penalty that encourages a person to behave in a certain way Competition- the struggle among producers for the dollars of consumers Invisible hand- a term coined by Adam Smith to describe the selfregulating nature of the marketplace Consumer sovereignty- the power of consumers to decide what gets produced Centrally planned economy- an economic system in which the government makes all decisions on the three key economic questions Command economy- another name for a centrally planned economy Socialism- a range of economic and political systems based on the belief that wealth should be evenly distributed throughout society. Communism- a political system in which the government owns and controls all resources and means of production and makes all economic decisions Authoritarian- describing a form of government that limits individual freedoms and requires strict obedience from its citizens Laissez faire- the doctrine that government generally should not intervene in the marketplace Private property- property that is owned by individuals or companies, not by the government or the people as a whole Mixed economy- a market-based economic system in which the government is involved to some extent Economic transition- a period of change in which a nation moves from one economic system to another

Privatization- the process of selling businesses or services operated by the government to individual investors, and then allowing them to compete in the marketplace Free enterprise system- an economic system characterized by private or corporate ownership of capital goods

2/8/2013 9:55:00 AM

2/8/2013 9:55:00 AM