CECN 603 Session 2
Topics: Economic Systems, Resource Allocation and Social Well–being
Readings: PB Ch 3, 5, FFS Ch 2, SRG Ch 2
Economic Systems:
Scarcity
• is the fundamental challenge confronting all individuals and nations.
• We all face limitations... so we all have to make choices.
• We can’t always get what we want. How we deal with these limitations—that is, how we
prioritize and allocate our limited income, time, and resources—is the basic economic
challenge that has confronted individuals and nations throughout history.
• But not every nation has addressed this challenge in the same way.
• Societies have developed different broad economic approaches to manage their
resources.
• Economists generally recognize four basic types of economic systems—traditional,
command, market, and mixed—but they don’t completely agree on the question of which
system best addresses the challenge of scarcity.
A traditional economic system is—here’s a shocker—shaped by tradition.
• The work that people do, the goods and services they provide, how they use and
exchange resources… all tend to follow long–established patterns.
• These economic systems are not very dynamic—things don’t change very much.
• Standards of living are static; individuals don’t enjoy much financial or occupational
mobility.
• But economic behaviors and relationships are predictable.
• Today you can find traditional economic systems at work among Australian aborigines and
some isolated tribes in the Amazon.
• In the past, they could be found everywhere—in the feudal agrarian villages of medieval
Europe, for example.
In a command economic system or planned economy,
• the government controls the economy.
• The state decides how to use and distribute resources.
• The government regulates prices and wages; it may even determine what sorts of work
individuals do.
• Socialism is a type of command economic system.
• Historically, the government has assumed varying degrees of control over the economy in
socialist countries.
• The classic (failed) example of a command economy was the communist Soviet Union.
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• The collapse of the communist bloc in the late 1980s led to the demise of many command
economies around the world; Cuba continues to hold on to its planned economy even
today.
In market economies:
• Economic decisions are made by individuals.
• The unfettered interaction of individuals and companies in the marketplace determines
how resources are allocated and goods are distributed. Individuals choose how to invest
their personal resources—what training to pursue, what jobs to take, what goods or
services to produce.
• And individuals decide what to consume. Within a pure market economy the government
is entirely absent from economic affairs.
A mixed economic system
• Combines elements of the market and command economy.
• Many economic decisions are made in the market by individuals.
• But the government also plays a role in the allocation and distribution of resources.
• Canada today, like most advanced nations, is a mixed economy.
• The eternal question for mixed economies is just what the right mix between the public and
private sectors of the economy should be.
Why It Matters Today
• Half of the twentieth century went down as a global battle between defenders of free
markets (democratic capitalist nations, led by the United States) and believers in
command economies (the communist bloc, led by the Soviet Union).
• The US and USSR never went to war against each other directly, but dozens of smaller (yet
still tragic and significant) wars unfolded around the world as bitter fights over economic
systems turned bloody. Korea, Vietnam, Nicaragua, Afghanistan, Angola… millions of
people died in the various “hot” theaters of a Cold War fought to decide whether markets
or states should control economic affairs.
• The great irony was that the Cold War finally ended not on a battlefield, but because the
Soviet economy finally self–destructed by the late 1980s.
• For most of the world, the Soviet collapse proved that command economies were simply
inferior to the market–dominated mixed economies of the capitalist world.
• Of course, China – still ruled politically by an authoritarian Communist Party, even though
its economy is now more mixed if not exactly free – is now the biggest creditor nation to
the United States.
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Mechanisms of the Market Economy
Market structures:
• In general there are 4 market structures, pure competition, pure monopoly, oligopoly, and
monopolistic competition.
• Pure Competition:
Many firms producing identical (standardized) products.
Firms (sellers) have no control over market price: price taker.
Very easy or no entry barriers.
Mainly agricultural products.
• Pure monopoly:
Only one firm
No close substitute
The firm is a price maker
Entry blocked
Local utilities etc.
• Monopolistic competition:
Many firms producing differentiated products.
Firm has a power to control market price within a very limited boundary.
Relatively easy to enter the market.
Intense nonprice competition.
Many small shops near our places such as retail stores, restaurants, etc.
• Oligopoly:
Only few firms control the market with standardized or differentiated products.
(Limited) power to control the market price with mutual interdependence.
Strong entry barriers.
Steel, automobile, and many manufacturing fields.
Market Forces:
What Is Demand?
Demand is a relationship between a product’s price and quantity demanded.
• Demand is shown using a schedule or curve.
• The law of demand states:
The price of a product and the quantity demanded for the product are inversely related.
• Market demand is the sum of quantities demanded by all consumers in a market.
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Law of demand:
• Common sense and simple observation.
• Diminishing marginal utility: Buyers will derive less satisfaction or utility from each successive
unit of a product. Therefore, consumer will buy additional units if price is reduced.
• Income effect: At a lower price, the buyer can afford more of the good without giving up
any alternative goods.
• Substitution effect: At a lower price, the buyer has an incentive to substitute the cheaper
good.
Demand Curve:
• A rise in the price, other things remaining the same, brings a decrease in the quantity
demanded and a movement up along the demand curve.
• A fall in the price, other things remaining the same, brings an increase in the quantity
demanded and a movement down along the demand curve.