Reading Essentials and Study Guide

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Reading Essentials and Study Guide

Chapter 2: Economic Systems and Decision Making Lesson 1 Economic Systems

ESSENTIAL QUESTION

How does an economic system help a society deal with the fundamental problem of scarcity?

Reading HELPDESK

Academic Vocabulary

stagnation lack of movement emphasizing stressing

Content Vocabulary

economic system organized way a society provides for the wants and needs of its people traditional economy economic system in which the allocation of scarce resources and other

economic activity is the result of ritual, habit, or custom command economy economic system characterized by a central authority that makes most of the

major economic decisions socialism economic system in which government owns some factors of production and has a role

in deciding what and how goods are produced market economy economic system in which supply, demand, and the price system help people

make decisions and distribute resources; same as free enterprise economy market meeting place or mechanism through which buyers and sellers of an economic product

come together; may be local, regional, national, or global capitalism economic system in which private citizens own and use the factors of production in

order to generate profits

TAKING NOTES: Key Ideas and Details

As you read the lesson, complete a graphic organizer like the one below to identify ways in which a market economy differs from, and is similar to, a command economy.

Market Economy

Similarities Command Economy

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Reading Essentials and Study Guide

Chapter 2: Economic Systems and Decision Making

Lesson 1 Economic Systems, Continued

Economies Based on Tradition

Guiding Question: How does a traditional economy answer the basic questions of WHAT, HOW, and FOR WHOM to produce? Much of what we do comes from habit and custom. For example, why does a bride toss her flowers at a wedding? Why do we greet people by shaking hands instead of pressing our noses and foreheads against theirs, the custom among the Maori people of New Zealand. These practices have become part of our culture.

Characteristics

In a society with a traditional economy, the use of scarce resources and nearly all other economic activity is based on ritual (acts always done the same way), habit, or custom. Habit and custom also decide most social behavior. Individuals are generally not free to make decisions based on personal desires. Instead, they follow the customs of their elders and ancestors.

Examples

Many societies--such as the central African Mbuti, the Australian Aborigines, and other native peoples around the world--have traditional economies.

The Inuit of northern Canada in the nineteenth century give us an especially interesting example. For many years, Inuit parents taught their children how to make tools and survive in a tough climate by fishing and hunting. Their children, in turn, taught these skills to their children.

The Inuit also shared freely and generously with one another. When a walrus or bear was killed, it would be divided into pieces to distribute among the heads of families in the hunting group. The hunter most responsible for the kill had first choice. The second hunter chose next, and so on. The hunting group later shared their pieces of the animal with other families who were not involved in the hunt.

Hunters had the respect of the village, rather than the right to the whole animal. As long as skilled hunters lived in the community, the tradition of sharing allowed a village to survive the long, very cold winters, and the Inuits persisted for thousands of years.

Advantages

The main advantage of a traditional economy is that everyone knows what to do. Each person has a role. There is little doubt about WHAT to produce. If you are born into a family of hunters, you hunt. If you are born into a family of farmers, you farm. Also, there is little doubt over HOW to produce, because you do things mostly the same way your parents did. Finally, the customs and traditions of the society decide the answer to the question FOR WHOM. In some societies, you would provide for your immediate family. In others, such as the Inuit, you would share with all the families of the village. In other words, tradition decides how people live their lives.

Disadvantages

The main problem of a traditional economy is that it often discourages new ideas and new ways of doing things. The strict roles often end up punishing people who act differently or break the rules. The result tends to be economic stagnation and a lower standard of living than in other economic systems.

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Reading Essentials and Study Guide

Chapter 2: Economic Systems and Decision Making Lesson 1 Economic Systems, Continued

Reading Progress Check

Describing What are the advantages and disadvantages of a traditional economy?

Economies Based on Command

Guiding Question: How does a command economy answer the basic questions of WHAT, HOW, and FOR WHOM to produce? In a command economy, a central authority makes the major decisions about WHAT, HOW, and FOR WHOM to produce. A command economy can be headed by a king, a dictator, a president, a tribal leader, or anyone else who makes the major economic decisions.

A modern, and slightly more liberal, type of command economy is socialism. Socialism is an economic and political system in which the government owns some, but not all, of the factors of production. This means the government plays a major role in answering some, but not all, of the major WHAT, HOW, and FOR WHOM questions.

Characteristics

In a pure command economy, the central governing authority makes all of the major economic decisions. This means that the government decides if houses or apartments will be built. It also decides the best way to build them and who will live in them.

Sometimes the central authority is generous with the country's wealth and spreads it around to help everyone. Other times, the central authority steals much of the country's wealth for its leader or a group at the top. Often, the result is that people are forced to use other ways to get everyday supplies, such as bribing people who have access to the supplies.

Most command economies severely limit private property rights. People are not allowed to own their homes, businesses, and other productive resources, although they may have some personal items like clothing and tools. The government owns most of the resources in the economy.

Under socialism, the government's stated goal is to serve the needs of its people, not just enrich its leaders. Socialist economies are typically too large for the central authority to own and direct everything. However, as in a pure command economy, the major economic decisions are made for the people, not by them.

Examples

Modern examples of pure command economies are limited. They include a small number of dictatorships and small tribal economies around the world. In North Korea, for example, everything--even the media and tourism--is either owned or controlled by the government.

More important are the small and shrinking number of countries based on socialism. This group includes Cuba and Vietnam, as well as Venezuela under former president Hugo Chavez. The socialist

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NAME ________________________________________ DATE _______________ CLASS _________

Reading Essentials and Study Guide

Chapter 2: Economic Systems and Decision Making

Lesson 1 Economic Systems, Continued

version of the Soviet Union, or USSR, was another example, but it collapsed in 1991. Countries such as Denmark, Sweden, and Norway have moved away from socialism to capitalism, but still provide free universal education and health services, which are a feature of socialism.

Advantages

A major strength of a command system is that it can change direction in an extreme and fast way. The former Soviet Union went from a rural agricultural society in 1910 to an industrial nation in a few decades by emphasizing the growth of heavy industry. During this period, the central planners moved resources on a huge scale from farming and consumer goods to industrial production.

Another major advantage of a socialistic command economy is that it allows most citizens to receive some goods and services that they would otherwise not be able to afford. Cubans, for example, have access to universal health care. In a similar way, President Chavez tried to provide basic food, commodities, and electricity at below-market rates to Venezuelan citizens during his time in office.

The same is true of North Korea and the former Soviet Union, where many public services--including health, education, and transportation--were available to everyone at little or no cost. The many low-income citizens in these countries would not have been able to afford them any other way.

Disadvantages

Command economies have several major disadvantages. The first is that their leaders usually provide for themselves at the expense of the general population. High government officials have nice cars, houses, and plenty of food while the average citizen may be forced to go without.

In the socialist former Soviet Union, for example, generations of people had to go without basic consumer goods and satisfactory housing. Similarly, the current North Korean government puts a strong emphasis on defense spending while its people have suffered years of hunger. At times, the government even had to accept food aid from international sources because of terrible agricultural policies.

A second disadvantage of command or socialist economies is the loss of individual freedom. For example, someone who does not want the services of a national health care system ends up paying taxes to support it for others. Even the choices of where and how to live can be affected. In Cuba, doctors are required to live in the same buildings where they provide their services. This would be shocking in the United States.

Free state-controlled media such as radio and TV is another common feature of most socialistic countries. But the programming is usually limited to what the government wants its people to see. It is not open to what the people would choose. In North Korea, living conditions in other parts of the world are not shown because the government wants its people to think that they live in a modern, advanced society.

A third disadvantage is the production of low-quality goods. Workers who are unhappy with where and how they are supposed to work are often given quotas, or specific amounts, to fill as a way to stimulate production. This sometimes causes the workers to focus on filling their quotas rather than on producing quality goods.

At one time in the former Soviet Union, the government measured quotas for electrical motors in tons of output. So Soviet workers met their quotas by producing the world's heaviest electrical motors. The Soviets also made some of the most beautiful chandeliers in the world. However, the quotas for those were also measured by weight, so the chandeliers were also some of the heaviest in the world. Many were so heavy that they could not be safely attached to the ceiling and some fell to the floor.

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Reading Essentials and Study Guide

Chapter 2: Economic Systems and Decision Making Lesson 1 Economic Systems, Continued

A fourth disadvantage is that a large bureaucracy, or government administration, is required to run an economy with major elements of command decision-making. In the former Soviet Union, a huge number of clerks, planners, and other administrators was needed to make the production and distribution plans for even the most basic products. This structure slowed decision making and raised the cost of production.

In Venezuela--a modern economy tending toward socialism under Chavez--the government took over entire industries in the agricultural, financial, oil, and steel sectors. The government did this to pay for the "low cost" food and electricity provided to everyone. Now these industries required supervision, often by politicians whose decisions are guided by political goals, without much thought about economics.

A fifth disadvantage is that rewards for individual initiatives are rare in both command and socialist economies. In the early years of the Soviet Union, all workers were paid about the same, regardless of their occupation or how hard they worked. Doctors were paid about the same as factory workers, and most factory workers were paid about the same regardless of how much each worker produced. Wages are also relatively equal in many other modern socialist countries.

The result--and this is an important one--is that economies with the same wages for different occupations and effort do not provide much incentive for people to learn or work hard. Why, would you bother to go to college or take the time to master a valuable skill if you would not be rewarded?

Yet a sixth disadvantage is that a planning bureaucracy does not have the flexibility to deal with major problems, or even minor day-to-day ones. As a result, command economies tend to go from one crisis to the next--or collapse completely, as did the former Soviet Union.

This inflexibility is a bigger problem in a time of global trade. Almost all countries are connected now, so it is possible for a problem in one part of the world to quickly spread to another. Rapidly rising oil prices because of a hurricane in the Gulf of Mexico could affect countries as far away as Finland or Mongolia. But a small economy directed by a central planning authority may be slow to react and minimize the negative effects.

Finally, pure command economies usually stay comparatively small.. It is easy for a ruler to make all of the major decisions in a small tribal economy. But when the economy reaches the size of a small country, many decisions would be needed to make it grow at a decent rate. When the economy gets to the size of the former Soviet Union, it is so hard to work out the decisions that the country collapses without any outside pressure.

Even in a socialist economy, TINSTAAF--There Is No Such Thing As A Free Lunch- still applies. In more developed European countries such as Denmark, Sweden, and Norway, programs like free education and national health care are funded by tax rates much higher than those in the United States.

Reading Progress Check

Analyzing What are the major problems with a command economy?

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NAME ________________________________________ DATE _______________ CLASS _________

Reading Essentials and Study Guide

Chapter 2: Economic Systems and Decision Making

Lesson 1 Economic Systems, Continued

Economies Based on Markets

Guiding Question: How does a market economy answer the basic questions of WHAT, HOW, and FOR WHOM to produce? In a market economy, people make decisions in their own best interests. In economic terms, a market is an arrangement that allows buyers and sellers to come together to exchange goods and services. A market might be in a physical location, such as a farmers' market, or on a Web site, such as eBay. Regardless of its form, a market can exist as long as there is a way for buyers and sellers to interact.

Characteristics

A market economy has a great deal of freedom. People can spend their money on the products they want most, which is like casting dollar "votes" for those products. This tells producers which products people want most, thus helping answer the question of WHAT to produce. Businesses are free to find the best production methods when deciding HOW to produce. Finally, the income that consumers earn and spend in the market determines FOR WHOM to produce.

Market economies also offer private ownership of resources. A market economy is often described as being based on capitalism--an economic system where private citizens own and use the factors of production for their own profit or gain. The term capitalism draws attention to the private ownership of resources. The term market economy focuses on where the goods and services are exchanged. As a result, the two terms focus on different features of the same economic system.

Examples

Many of the most prosperous countries in the world base their economies on markets and capitalism. These countries include Australia, Canada, Great Britain, Japan, Singapore, South Korea, parts of Western Europe, and the United States. While there are significant differences among them, these economies share the common basics of markets and the private ownership of productive resources to make profits.

Advantages

The first advantage of a market economy is its high degree of individual freedom. People are free to spend their money on almost any good or service they choose. People also are free to decide where and when they want to work, or if they want to invest in their own education and training. At the same time, producers are free to decide what they want to produce and whom they want to hire. They are free to decide which inputs they want to use and the way they want to produce.

The second advantage of a market economy is that it adjusts to change over time. Before 2005, for example, gasoline prices were low, so people tended to buy large gas-guzzling SUVs. When the price of gas rose sharply in that year, SUV sales fell, and smaller, more fuel-efficient vehicles became popular. The decision that individuals made themselves--not decisions made by government planners--helped the economy adjust to change.

A third advantage is the relatively small amount of government interference. Except for certain concerns such as justice and national defense, the government normally tries to stay out of the way of buyers and sellers.

A fourth advantage is that decision making is spread out. Billions, if not trillions, of individual economic decisions are made daily. Together, consumers make the decisions that direct scarce resources into the uses they want most. In this way, everyone has a voice in the way the economy runs.

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Copyright ? McGraw-Hill Education. Permission is granted to reproduce for classroom use.

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Reading Essentials and Study Guide

Chapter 2: Economic Systems and Decision Making Lesson 1 Economic Systems, Continued

A fifth advantage of the market economy is the variety of goods and services that are produced. You can find ultrasound devices to keep the neighbor's dog out of your yard. You can download video and street maps to your cell phone. You can even use your cell phone as a flashlight. If a product can be imagined, it will probably be produced in hopes that people will buy it.

A sixth advantage is high consumer satisfaction. In a market economy, the choice one group makes does not affect the choices of other groups. If 51 percent of the people want to buy classical music, and 49 percent want to buy hip hop music, people in both groups can still get what they want.

Yet another advantage of a market economy is that goods are usually privately owned. Privately owned goods last longer than goods owned by others. For example, who would take better care of a new car or truck--the person who owns it, or the person who drives it for the owner? The answer almost always is that the owner would take better care of his or her property. In a world of relatively scarce resources, it makes sense to have an economic system that takes better care of property.

Exploring the Essential Question

Compare and contrast the three main types of economic systems, focusing on the basic elements of production and distribution of goods and services.

Disadvantages

The market economy does not provide for everyone. Some people may be too young, too old, or too sick to earn a living or to care for themselves. These people would have trouble surviving in a pure market economy without help from family, government, or charitable groups.

A market economy also may not provide enough of some basic goods and services. For example, private markets do not fully supply all of the roads, libraries, universal education, or comprehensive health care people would like to have. This is because private producers focus on providing products they can sell for a profit.

Finally, a market economy has a high degree of uncertainty. Workers might worry that their company will move to another country in search of lower labor costs. Employers may worry that someone else will produce better or less expensive products, and so take their customers.

Reading Progress Check

Identifying What are the main benefits of a market economy?

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