Basic Economic Decisions

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Basic Economic Decisions
for all types of Economic Systems
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1. What should be produced.
2. How should it be produced.
3. Who should receive it?
4. Can the system adjust?
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How Decisions are Made
Using an Economic System
Method of organizing the relationship between
businesses, households and the government to make
the production decisions
4 Types
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1. Agrarian or Traditional

• - Follow in family business
• Usually smaller groups
• Few true examples

A. What?
What the family business has been producing (for
generations)
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1. Agrarian or Traditional
B. How?
Using the same method that have been used (for
generations) No incentive for change
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1. Agrarian or Traditional
C. For Whom?
Determined by place in society.
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1. Agrarian or Traditional
Strengths

• Economic security
• Strong family/community ties

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1. Agrarian or Traditional
Weaknesses

• Resistant to change
• Few economic incentives/freedom
• Limited goods and services available
• Keeps social order

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2. Market Economies

• - Based on price system
• Interaction of buyers and sellers
• Involves private property rights

A. What?
- Goods and services that are profitable - Goods
and services consumers want.
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2. Market Economies
B. How?
Efficiently- least cost combination of resources
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2. Market Economies
C. For Whom?
Those who can pay.
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2. Market Economies
Strengths

• Efficient production
• Prices coordinate production
• Provides a wide variety of goods
• Able to adjust for changing demand

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2. Market Economies
Weaknesses

• Not always socially desirable goods
• No economic security
• Imperfect knowledge about goods that are available

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3. Planned Economies

• Government owns resources
• Government make production decisions

A. What?

• Goods needed to meet economic planning targets

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3. Planned Economies
B. How?
Aimed at achieving targets Switch resources
around to meet targets
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3. Planned Economies
C. For Whom?
Government decides who gets goods Bonuses for
important workers
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3. Planned Economies
Strengths

• Can achieve social goals
• Can eliminate unemployed resources
• More equitable distribution of goods
• More easily able to adjust resources

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3. Planned Economies
Weaknesses

• Over or underproduction
• Few incentives for workers
• Few choices for consumers
• Increasingly complex process

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4. Mixed Economies

• Combine aspects of market and planned economies
• Includes almost all economies

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4. Mixed Economies
Coordinating Mechanism
Market System Planning
Nazi Germany
Private Public
US
Resource Ownership
Cuba
China
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Problems With Transition from Planned to Market
1. People are used to government direction
2. Shortages of expert in Market operations
a. Legal b. Marketing c. Accounting
3. Inflation finding market value of goods
and services
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Which Market Type??
1. Businesses are free to produce what ever they
want and are always looking for cost-cutting
techniques of production.
Mixed?
Market?
Traditional?
Planned?
Market
Market
Market
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Which Market Type??
2. An Economics Instructor does not bother to
explain the circular flow because it has no
relevance to how the basic decisions of the
country are made.
Planned
Planned
Planned
Traditional?
Planned?
Mixed?
Market?
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Which Market Type??
3. Union and management representatives submit a
deadlocked labor contract negotiation to the
government for mediation.
Mixed
Mixed
Mixed?
Traditional?
Mixed
Planned?
Market?
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Which Market Type??
4. Workers who have lost their jobs and incomes
cut back their spending because there is no
alternative source of emergency financial support
once their savings runs out.
Market
Mixed?
Market
Market?
Traditional?
Planned?
Market
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Which Market Type??
5. Consumers are unable to obtain carburetors
and windshield wiper motors for their cars
because they are not being produced, yet
accordions, which are plentiful and not in
demand, continue to be produced.
Planned
Planned
Planned
Traditional?
Planned?
Market?
Mixed?
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Which Market Type??
6. A catering business goes bankrupt, but its
employees receive unemployment compensation while
they look for other jobs.
Mixed
Market?
Mixed
Mixed
Traditional?
Planned?
Mixed?
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The Circular Flow of Goods and Services
Factor Markets
4 Participants
Households
Businesses
Product Markets
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The Circular Flow of Goods and Services
Factor Markets
Resources
Payments and Legal
Resources
with Government Involvement
Business Taxes
Income Taxes
Goods and Services
Goods and Services
Households
Businesses
Goods and Services
Payments
Product Markets
Payments
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Government Involvement in the Circular Flow
With Households
It Provides
Legal Framework Infrastructure Security
It Gets
Taxes
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Government Involvement in the Circular Flow
With Businesses
It Provides
Legal Framework Infrastructure Security
It Gets
Taxes
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Government Involvement in the Circular Flow
With Factor Markets
It Provides
Legal Framework Infrastructure Security
Factor Payments
It Gets
Factors of Production
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Government Involvement in the Circular Flow
With Product Markets
It Provides
Legal Framework Infrastructure Revenue Payments
It Gets
Goods and Services
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The US System
1. Adam Smiths The Wealth of Nations
(new theory) The best way to increase the wealth
of a country is through individual decision
making with minimal government influence. Laissez
faire
(old theory) Mercantilism government formed
economic policy. -It granted charters for
colonies to produce certain goods
(new) The Invisible Hand people serve their own
interests. They produce what is in demand and
will profitable.
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The US System
2. Industrial Revolution
a. Inventions made large-scale production
possible. mass production, factory system -
long hours, poor working conditions
b. Creates a need for inputs and a need for
markets
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The US System
3. US Development
a. Growth in transportation and communications
opened new markets
b. Electricity and oil allowed for mass
production

• New goods were invented
• -typewriters, light bulbs, automobile, new farm
  machinery

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The US System
d. Problems developed
1. Large businesses became monopolies and trusts

• Living conditions became harsh
• - long hours, low wages, slums, child labor

3. Government Response

• Anti-trust legislation
• - FTC, Food and Drug Act, Sherman Anti-Trust Act

b. Movement away from laissez
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The US System
4. The Great Depression
a. Problems of the 20s.
- production for WWI not needed any longer -
tariffs eliminated markets - farmers were
overproducing - unemployment rising - inside
of the Production Possibilities Curve
b. Creates a need for inputs and a need for
markets
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The US System
b. The government took action
- farmers paid not to grow - government work
projects set up - Social Security created -
FDIC - Employment Act of 1946
Government required to take action - full
employment - full production - stable prices
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The US System
c. Recent Trends
- Reagan and Carter - deregulation
- Reagan and Bushes large deficits
- Clinton balance budget, sex
- George W. tax cuts, large deficits