Published on February 5, 2009
THE ECONOMIC SYSTEM Chapter 2 ECONOMICS: its concepts and principles By: BKG Gabay RM Remotin, Jr. EAM Uy Prepared by: GREGAR DONAVEN E. VALDEHUEZA, MBA Lourdes College Instructor
OBJECTIVES: This chapter examines the subject that many economists consider to be the fundamental problems of economics, different economic system and its significance, law of scarcity, and production possibility frontier.
The three basic economic problems 1. What goods and services should be produced and in what quantities? 2. How should these goods and services be produced? 3. For whom should these goods and services be produced?
What goods and services to be produced? It is not always possible to produce all goods and services that people want because resources are limited. From the available resources can only be produced a limited quantity of goods and services, and when the maximum combinations of goods and services that can be produced has been reached, an increase in the quantity of the said product connotes a decrease in quantity of another.
How should these goods and services be produced? As a rule of thumb, goods and services must be developed or produced at its optimum level – that is maximum output with a minimum input without sacrificing the quality.
For whom should these goods and services be produced? “who should consume the produced goods and services?” With this regard to this question, we should think also whose generation will receive these goods and services: the present or the future generation.
Four (4) factors of production Land. Land is not only the soil for growing agricultural products. It is also the source of all materials and food whether in liquid, solid, or gaseous form, in or above the earth. Labor. It refers to human effort, when the effort is rewarded by some kind of pay. This refers also to the available physical and mental talents of the people who have to produce goods and services.
Capital. The word comes from the Latin ‘caput’ which means ‘head’. It refers to the tangible, physical good (a capital good) that a person or society creates in the expectation that its use will improve or increase future production. That is the reason why this term also connotes the facilities of goods. Entrepreneurship. Entrepreneurship means that people are combining the other three factors of production to create some products or services to sell. They hope for profit, but take risk loss or bankruptcy.
The process of creating a capital good is called capital formation. A common term for capital formation economics is investment. Notice again that we are not talking about money. Outside of economics, the purchase of assets such as stocks and bonds is sometimes called financial investments. This term should be distinguished from investment as economists use the term. When a group of fishermen, the labor factor, takes time to make a boat, it is creating capital. The fisherman is investing in the hope that in the future the boat will increase the number of fish the fisherman catches, the increase in fish caught representing the fisherman’s return on his investment. The fisherman’s capital formation (investment) is measured by sacrifice consumption (the fish that weren’t caught for food or clothing).
According to Starr in his book, for a nation as a whole, however, money represents only a claim on the resources owned by that nation – the real things like buildings, roads, dams, TV sets, automobiles, and raw materials. If we are going to count a nation’s supply of money plus its supply of real things, we would be guilty of what all economists call double accounting. Although money is a means to acquire factors of production and is also a measure of wealth, it is not in itself a factor of production.
The Economic System Refers to a set of economic institutions that dominate a given economy with the main objective of solving the basic economic problems.
Four economic systems or categories: Traditional Economy Essential characteristics: Communal land ownership; The leader decides on the management of agricultural production which is the basis of the economy; The production, distribution, and use of economic resources are based on traditional practices; New technologies are not welcomed since they are in contrast with the traditional practices of their ancestors; The economy is only its third priority while culture and religion are its foremost priorities; Mines are used to gather raw materials for production.
Command Economy Essential characteristics: Resource allocation is done by government; Presence of central planning of all economic activities; There is no free competition (the government is only seller); Only the government plays the role in setting legal framework for economic life production and distribution of goods and services; The products or needs of the people are distributed based on priorities set by the committee.
Market Economy Essential characteristics: The private sector owns and manages the means of production; The price system in a market structure applies to determine how much will be paid for a certain commodity or service; It is also known as laissez-faire or free enterprise; There is minimum government interference on decisions pertaining to the management of the economy (protection of the society against internal and external aggression); Existence of competition often results to monopoly; There is presence of economic power.
Mixed Economy Essential characteristics: The means of production are owned and controlled by the private sector as well as the government; The people decide on economic activities within the economy; The combinations of the best features of capitalist and command economies are observable in the market; The problem of distribution of goods and services and allocation of economic resources are determined through a combination of the market and governmental laws and policies.
In the real situation, economic systems are rarely 100 percent examples of any one system. At present, there is no economy today applying a pure economic system. Majority, if not all, of these economic systems are present in varying degrees in any economy. The Philippines, for example, is best described as a market system but it contains many command elements like regulatory agencies and executive orders issued by the president. Traditional system elements are quietly observed, like in the way many young people choose their parents’ occupation. But in a way, most economic systems are mixed, although they are usually identifiable as being predominantly of one type or another.
The three ISMS: Capitalism, Communism, and Socialism The classification of different societies into traditional, command, market and mixed economic systems spans the entire course of history, but in the last century the world has been divided into great economic and political systems representing socialism and capitalism. Capitalism - is an economic system in which most resources are privately owned, people are free to choose their occupation, the kind and amount of production is determined by price and people searching for a profit, and there is substantial amount of competition.
Three aspects of Capitalism: The institution of private ownership is generally accepted. Factories, land, goods, and services are privately owned by individuals or group of individuals like stockholders and shareholders. Most people are free to pursue their own economic self-interests, that is, to work for personal gain. For this reason, capitalism is often called the free- enterprise system; most people are free to choose their own occupations. Because people are motivated by self-interest, they compete with one another to get ahead, to make a better product, to control markets in order to maintain or obtain a large profit. There is always a struggle for larger profit lead (usually, but by no means always) to a high degree of competition among business.
Communism - holds that the people themselves, not the government, own the means of production. In a communist state, everyone works at what he or she can do best. There is no system of wages or profits needed to spur people to work. Everyone simply takes from what is produced whatever he or she needs to live comfortably. No government or bureaucracy supervises what the people do.
Socialism - is an economic system in which the government owns and operates the major industries of the country. It means also that the government also decides in those major industries the answers to the three economic questions. Socialism does not imply dictatorship. Spcialism can exist in democratic countries as well as authoritarian ones. The main reason for socialism’s existence is that socialists hope to overcome capitalism’s two important problems. 1. The unequal distribution of income and wealth 2. The uneven course of economic growth with periods of boom or bust.
The circular flow of economy Goods and Services Factors of Production (land, labor, capital, entrepreneur) Household Business Sector Sector Payments of Factors (rent, wages, interest, profit) Payment of Purchase of goods and services.
The law of scarcity Scarcity - refers to the condition that all resources are available only in limited supply. Law of Scarcity - states that goods are scarce because there are not enough resources to produce all the goods that the people want to consume.
Types of resources: Society Land Forests Minerals Human Mental Physical Manufacture Aids to Production Tools Machinery Buildings
Commodities - things produced Types of Commodities Goods (tangibles e.g. cars, clothes, shoes) Services (intangibles e.g. haircut, massage, education) Production - the act of making goods and services Consumption - the act of using them to satisfy human wants
Social Costs of Individual Decisions - a personal decision may impose costs, not just to oneself, but also on others. Consequently, the total cost to society – social cost – is measured by the opportunity costs borne by individuals for their own decisions plus additional costs that may be borne by others.
Production Possibilities Frontier (PPF) PPF illustrates three concepts: Scarcity – indicated by the unattainable combination above the boundary Choice – can be seen by the need to choose among the alternative attainable points along the boundary and opportunity cost Opportunity cost – refers to the cost of using them in their best alternatives.
Production Possibility Boundary/Frontier unattainable combinations production possibility Service for Education boundary attainable combination Health Services
The reason why PPF is downward sloping because of Opportunity cost. Due to the opportunity cost, trade-off arises. Trade-off - a situation in which more of one good thing can be obtained only by giving off another thing.
Two factors why available goods and services are not enough to satisfy the human’s material wants: Unlimited human wants Limited quantity of goods
-END- Thank you! Any questions? If none, then you may go.
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