Lecture 3: Economic Institutions and Types of Economies PDF

Lecture 3: Economic Institutions and Types of Economies I. The Three Big Questions Revisited There are three main questions for which the economy determines the answers: 1. What, and how much, to produce. 2. How to produce it. 3. For whom to produce i...

Lecture 3: Economic Institutions and Types of Economies I. The Three Big Questions Revisited There are three main questions for which the economy determines the answers: 1. What, and how much, to produce. 2. How to produce it. 3. For whom to produce it. ALL of these questions deal with the notion of resource allocation II. Types of Economies 1. Market economy (Laissez-Faire) – market mechanism Allocation and choices are left solely to the market No government intervention Answering economic questions: What? – resources are allocated to goods people are willing and able to buy How? – Economize and efficiently For whom? – people willing and able to pay the price being charged  the PRICE of goods and resources determines what is used, how, and for whom The Price is the sole allocation mechanism in a pure market economy  CAPITALISM – PRIVATE OWNERSHIP OF RESOURCES 2. Command Economy – the government or ruling body determines what is produced, how it is produced, and who gets it. (Collective Decision Making) a. What? – what the gov’t determines is appropriate b. How? – what is wanted and needed for production - rarely cost effective - prices of resources are irrelevant - wasteful production; less motivated labor force; incentives? c. Who? – determined by government - commonly suggested that it will be equally distributed - however, it often goes to those in power A CENTRAL PLANNER Countries still close to this – DRCongo, North Korea, Cambodia, Sudan, … COMMUNISM – communal or government ownership of resources - SOCIALISM 3. Mixed Economy – most economies today are mixed economies If PRICE works as an allocator – why does government intervene? Consider: What? Market for space travel, roads, … How? Cheapest manner is not necessary socially the best Pollution, child labor, safety Who? Should minors buy cigarettes? Should under 21 be able to buy alcohol? Welfare programs? Drugs? Prostitution? WELFARE CAPITALISM – hybrid of socialism and capitalism III. Taxonomy of a Market Economy Two components of a market economy: 1. Economic Agents (or decision makers) a. Households – a singular unit making economic decisions b. Firms – producers of goods and services in the economy c. Government – regulators – referees – enforcers 2. All of these are interrelated through MARKETS Markets – where buyers and sellers come together for exchange Two types of markets a. Goods and services b. Factors of production Land - Rent Labor - wages Capital - interest Entrepreneurial skills – profit CIRCULAR FLOW DIAGRAM OF A SIMPLE ECONOMY A Resource Market and a Factor Market are the SAME THINGS A Product Market and a Goods Market are the SAME THINGS