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Economics: Theory & Practice 9

th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Chapter Two:
Economic Decision Making & Economic Systems
Chapter Objectives
2-2
To introduce the basic economic choices that must be made in every society because of scarcity.
To describe differences among traditional, market, and planned economies, and how the basic economic
choices are made in each of these systems.
To understand basic economic decision making in traditional, or agrarian, economies.
To explain how market economies are structured and how they operate.
To explain why, where, and how government intervenes in mixed economies, chiefly the U.S. economy.
To explore decision making in and to evaluate planned economies.
To distinguish between capitalism and socialism and to describe how these two systems relate to
individual and collective economic decisions.
To explore the British foundations and the historical highlights of the U.S. economy.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Chapter Overview
Basic Economic Decisions
Introduction to Economic Systems
Agrarian Economies
Market Economies
Planned Economies
Mixed Economies
Changing Economic Systems
Chapter Two
2-3
The U.S. Economic System
Historical Highlights of the U.S. Economy
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Basic Economic Systems
2-4
Basic Economic Decisions:
The choices that must be made in any society regarding what to produce,
how to produce, and to whom production is distributed..
What goods and services to produce and in what quantities?
Everyone in society has endless wants, but only limited varieties
and amounts of consumer and capital goods can be produced.

How to produce these goods and services, or how to use the
economys resources?
Products can be made in a number of different ways.

Who gets these goods and services?
Focuses on distribution.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Introduction to Economic Systems
2-5
Economic Systems:
The way in which an economy is organized to make the
basic economic decisions..
Agrarian economies:
Decision making is based on tradition.
Market economies:
Decision making is made by buyers & sellers
through prices in marketplaces.
Planned economies:
Decision making is a collective effort.
Mixed economies:
Combine market & planned systems.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Agrarian Economies
2-6
Traditional, or Agrarian, Economies:
An economy that relies largely on tradition, custom, or ritual when
making the basic economic decisions.
Fairly small, close, and rural, and they often work to support all members.
Allocate a larger distribution of goods and services to those with a defined
social status within the society.
Barter:
The direct exchange of
goods or services for
other goods or services.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Market Economies
2-7
Market Economies:
An economy in which the basic economic
decisions are made by individual buyers
and sellers in markets using
Also called price systems:
A market system; one in which buyers and
sellers communicate through prices in markets.
Private property rights are essential to
these systems:
Individual rights to possess and dispose of
goods, services, and resources.
Ability to engage in free enterprise:
The right of a business to make its own
decisions and to operate with a profit motive.
Ability to engage in capitalism:
An economic system with free enterprise and
private property rights; economic decision
making occurs in a market environment.
A pure market economy can
best be illustrated by using a
circular flow chart
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Market Economies
2-8
Market Economies:
Rely on millions of independent decisions by individual households and businesses in
the marketplace to determine what to produce.
Comprised of myriad businesses that usually utilize the least-cost method of production.
Free Enterprise:
Utilize the price system to determine who receives goods and services.
People have access to goods and services only if they can pay for them, and their
ability to pay is determined by the number and value of resources that they, the
people, offer to businesses.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Market Economies
2-9
Market Economies:
Rely on millions of independent decisions by individual households and
businesses in the marketplace to determine what to produce.

Comprised of myriad businesses that usually utilize the least-cost
method of production.

Utilize the price system to determine who receives goods and services.
People have access to goods and services only if they can pay for
them, and their ability to pay is determined by the number and value
of resources that they, the people, offer to businesses.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Market Economies
2-10
Market Economies:
Unparalleled opportunity for growth and change.
Those born into poverty have the ability to transcend that barrier and ascend
the economic ladder.
Lack of consideration given by some businesses when profit is a prime motive.
Can lead to lower business costs, but will lead to higher costs for society due
to hazardous products or poor working conditions.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Market Economies
2-11
Other Key Concepts
Output Markets (Product Markets):
Markets in which businesses are sellers and households are buyers; consumer goods and services are exchanged.

Input Markets (Resource Markets):
Markets in which households are sellers and businesses are buyers; factors of production are bought and sold.

Low-Cost (Efficient Method of Production):
The method of production that allows a good or service of a given quality to be produced at the lowest cost.

Market Failure:
A market system creates a problem for a society or fails to achieve a societys goals.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Market Economies
2-12
Government Intervention in Market Economies:
Government regulation - government commissions & boards are involved in business decision making.
Society frequently turns to the government for help when it wants to address market failures.
Economies are no longer pure after such intervention.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Planned Economies
2-13
Planned Economies:
An economy in which the basic economic decisions are made by planners rather than
by private individuals and businesses.
Also called command economies.
Look to planning authorities to instruct enterprises on how to produce various items.
Trust in planning authorities to distribute goods and services.
Socialism: An economic system in
which many of the factors of
production are collectively owned,
and an attempt is made to equalize
the distribution of income.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Mixed Economies
2-14
Mixed Economies:
An economic system with some combination of market and centralized
decision making.
Pure market and pure planned economies are used as a basis, but neither have
real-world counterparts, and neither are perfect in their design.
As market economies experience problems, they tend to move away from
pure market to mixed economies, and as planned economies experience
failures, they move away from pure planned to mixed economies.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Changing Economic Systems
2-15
Beginning in the mid-1980s, dramatic changes occurred in many of the
worlds planned economies.

Privatization the granting to individuals of property rights to factors of
production that were once collectively owned, or owned by the state.

The Soviet Union, Poland, Hungary, and other nations began moving
toward greater use of free markets and individual decision making.

Privatization allowed individuals to be granted property rights to factors
of production that were once collectively owned, or owned by the state.

Problems have arisen in the transition from planned economies to market
economies due to economic problems that defy simple or obvious solutions.

One lesson learned from these experiences is that, while the commitment
to change may be professed quickly, change itself comes slowly.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
The U.S. Economics System
2-16
The U.S. economy has been described as a mixed economic system; one that primarily depends
on markets and individual decisions, though some government intervention is also present.

Resulted from the transformation of England and Scotland into industrial market economies.

This began with the rise of economic individualism.

In his book The Wealth of Nations in 1776, Scottish philosopher Adam Smith proposed a new
economic system called laissez-faire (let it alone) capitalism which challenged the reigning system
of mercantilism in which the state was deemed to be the best judge of what is good for an
economy.

Central to Smiths argument for a new economic system was his invisible hand doctrine.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
The U.S. Economics System
2-17
Laissez-Faire Capitalism is Capitalism with a strong emphasis on individual
decision making; little or no government interference.

Mercantilism is an economic system or philosophy that subordinates individual
interests and decisions to those of the state.

The Invisible Hand Doctrine is Adam Smiths concept that producers acting in their
own self-interest will provide buyers with what they want and thus advance the
interests of society.

The Industrial Revolution is a time period during which an economy becomes
industrialized; characterized by such social and technological changes as the growth
and development of factories.
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Highlights of the U.S. Economy
2-18

Prior to the Civil War, the U.S. economy was primarily agricultural, but following the Civil
War substantial and significant changes occurred due to an industrial boom experienced
throughout the majority of the country.

With this boom in the economy came regulation of companies that were becoming large and
might be able to monopolize markets.

Along with regulation of monopolies, the government intervened in other problems, such as
the harsh living and working conditions.

The next round of government interventions would come in the form of the New Deal.

Muckrakers were authors, journalists, and others who sensationalized American social
problems in the early twentieth century.
Along with the progress made by England and Scotland
between the 17th and 19th centuries, the evolution of the U.S.
economy was brought about by several key events in the U.S:
Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Highlights of the U.S. Economy
2-19
Due to the stock market crash of 1929 and the following economic decline, the New Deal created
New Deal which was a series of programs and legislative reforms instituted during the administration
of Franklin D. Roosevelt in the Great Depression of the 1930s.

The next big intervention made by the government would come in the form of the Employment Act of
1946, which was legislation giving the federal government the right and responsibility to provide an
environment for the achievement of full employment, full production, and stable prices.

Regulatory activities increased in the 1960s and the 1970s, until a deregulation trend developed in the
late 1970s and continued in the 1980s as part of the Carter and Reagan administrations.

Since the 1980s, the federal debt has risen dramatically.

By 2003 the debt exceeded $6.5 trillion, and the regulatory activity trend was once again reversed.
Along with the progress made by England and Scotland
between the 17th and 19th centuries, the evolution of the U.S.
economy was brought about by several key events in the U.S:

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