Economic Systems

 Classifying economic systems

0. methods of classification
1. classification by degree of
government control
1. command economies
2. free-market economies
3. mixed economies
2. other classifications
4. the informal economy
5. the not-for profit sector

 The command economy

✜ featuresof a command economy
✜ planning
 consumption and investment
 matching of inputs and outputs
 distribution of output
 Advantages of a command
economy
✜ highinvestment, high and stable
growth
✜ social goals pursued
✜ low unemployment

 Problems of a command economy

✜ problems of gathering information
✜ expensive to administer
✜ inefficient allocation of resources
 inappropriate incentives
 no system of prices
– shortages and surpluses
– lack of response to consumer demand
 The free-market economy
✜ based on free decision making by
individuals and firms
✜ demand and supply decisions
✜ the price mechanism
 shortages and surpluses
– shortage → price rises
– surplus → price falls
 equilibrium price
– where demand equals supply
 response to change in demand and
supply
 Interdependence of markets
✜ effect of a rise in demand
 effect in market for that good
 effect in factor markets
 effect in other goods markets
 effect in other factor markets

 Competitive markets
✜ perfectly competitive markets
✜ everyone is a price taker
✜ why study perfect markets?
 Demand

The relationship between demand

and price
✜ the income effect
✜ the substitution effect

 The demand curve

✜ assumptions

✜ the axes
✜ illustrates
how much would be
demanded at each price
 Other determinants of demand
✜ tastes

✜ number and price of substitute goods

✜ number and price of complementary
goods
✜ income

✜ distribution of income
✜ expectations

Movements along and shifts in the

demand curve
 Supply
 Relationship between supply and
price
✜ as price rises, firms supply more
 it is worth incurring the extra unit costs
 they switch from less profitable goods
 in the long run, new firms will be
encouraged to enter the market

 The supply curve

✜ assumptions

✜ the axes
✜ illustrates
how much would be
supplied at each price
 Other determinants of supply
✜ costs of production
✜ profitability of alternative products
✜ profitability of goods in joint supply
✜ nature and other random shocks
✜ aims of producers
✜ expectations of producers

Movements along and shifts in the

supply curve
 The Determination of Price

 Equilibrium price and output

✜ response to shortages and surpluses
✜ significance of “equilibrium”

 Demand and supply curves

✜ effect of price being above equilibrium
 surplus → price falls
✜ effect of price being below equilibrium
 shortage → price rises
✜ equilibrium: where D = S
 Effects of shifts in the demand
curve
✜ movement along S curve and new D
curve
 rise in demand (rightward shift) → P rises
 fall in demand (leftward shift) → P falls

 Effects of shifts in the supply curve

✜ movement along D curve and new S
curve
 rise in supply (rightward shift) → P falls
 fall in supply (leftward shift) → P rises
 The Free-market Economy
Advantages of a free-market
economy
✜ transmits information between buyers
and sellers
✜ no need for costly bureaucracy
✜ incentives to be efficient
✜ competitive
markets respond to
consumer wishes

 Problems of a free-market economy

✜ competition may be limited
✜ inequality

✜ environment and social goals may be

ignored
 The mixed economy
✜ types of intervention
 use of taxes, subsidies and benefits
 legislation and regulation
 direct provision by the government