Back to ECONOMICS STUDY PAGE

Back to ACHIEVE Home Page

Go to ECONOMICS TERMS

You have already learned that a country's economic system will provide the answers to the three basic economic questions. The answers will not be the same for every country because of the availability of resources.

Time out for a quick review!

Simply stated, economics is about how people and countries try to answer three basic questions:

(1) What should be produced?

(2) How should products be produced?

(3) For whom should these products be produced?

Remember to look at the graphics.

The answers to the three economics questions will be determined by the same items that social scientists study. Specifically, what is the quality or quantity of the factors of production (land, labor, capital, and management) that are available to the country?

Point to Ponder!

A underdeveloped country has the largest deposit of coal in the world. That is the good news. The bad news is that the coal is so high in sulfur content that it cannot be used by industrialized nations because of air pollution standards.

Today, few if any, economic systems are fully traditional, fully controlled, or fully free. Most are a mixture of two or more types. As you read this material, ask yourself the following questions:

What are the main features of each of the three basic economic systems?

How do the three economic systems differ in the way each answers the basic economic questions?

Economic systems are usually divided into three categories:

traditional, controlled, and market or free economic systems.

In a traditional economic system, the three basic economic questions are answered, "As we have always done." In other words, nearly all economic decisions are based on age-old traditions, customs and beliefs.

The traditional economy was especially strong when most of the individuals were involved in farming.

Point to Ponder!

At the time of the American Revolution, over 90% of the population worked on farms. It was very important that all of the members of the family were involved in the raising of food products. Families, especially in the New England colonies, had to stay together so that enough food could be raised so the family could survive. Neighbors had to work together to ensure that all of the field work would be completed.

By 1820, 72% of the population worked in agriculture. The farms were passed on from generation to generation as sons joined their fathers to work the land.

The improvements of farm machinery in the first half of the 19th century meant that fewer people were needed to feed the nation. In 1840, one farmer fed 4 1/2 people.

In 1870, 53% of the labor force still worked on the farms. As a result of the development of new technology between 1870 and 1900, fewer people were needed on the farms.

By 1900, only 37% of the labor force worked on the farms and in 1930 the number had fallen to 21%.

Today, a farmer feeds over 90 people, while less than 2% of the U.S. population works on farms.

In less than 200 hundred years, the traditional economy of the United States had been completely reversed by changes in technology.

The lifestyles of peoples around the globe have been dramatically changed as a result of technology. Examples of these changes range from the Native American tribes of North and South America to the proud cultures of the people of African, Asian, and European nations.

A modern example of a traditional economic lifestyle would be the Eskimos in North America. However, the use of rifles, snowmobiles and modern housing are a threat to the continuation of this traditional way of life.

CONTROLLED ECONOMY

In a controlled economic system, the average person has little influence on how the basic economic questions are answered. The questions of what to produce, how to produce, and for whom to produce are basically answered by a group of government planners.

Before 1992, the countries of the Soviet Block in eastern Europe were under controlled economic systems. The government would decide what consumer goods should be produced. The price of these consumer goods was set by the government planners.

After the fall of the Soviet Union, some of the Eastern European countries adopted many aspects of the market economic systems while retaining a large amount of government control.

Remember, in a controlled economic system, the decisions as to what to produce are made by government planners. The individual has little choice but to follow the planners' decisions.

In a market - or free - economy, the average person has much to say in the making of economic decisions. By buying or not buying goods and services, consumers help to provide answers to the basic economic questions. A look at the market, or capitalist, economy of the United States will help you understand these concepts.

Point to Ponder!

The United States in the late 1970s produced more than 8 million automobiles per year.

ECONOMIC APPLICATION TOOLS

You now have the opportunity to use the economic tools that were identified in lesson two: demand, supply and scarcity.

The consumers played an important part in the making of these economic decisions.

When trying to decide what to produce, American producers noted the willingness of consumers to buy automobiles.

The production of automobiles to meet this demand seemed to be a wise economic choice.

The answer to the problem of how to produce also was influenced by consumers. Because of the great demand, the producers moved more of their resources to the production of automobiles.

The consumer demand for automobiles helped the producers to decide how many automobiles to produce. Competition between producers kept prices down and production methods efficient.

Consumers also helped to determine the distribution of these automobiles.

The amount of money consumers were willing and able to spend on goods such as automobiles influenced the prices that producers charged.

The level of prices, in turn, helped decide who would be able to afford to buy an automobile.

Therefore, we can say that in our free market, or capitalist economy, the producers reacting to consumer choices provide most answers to the basic economic questions. Please remember that producers are also consumers.

Producers must purchase the items they need in order to conduct their business. A grocery store delivery truck needs tires just like the family car.

However, we must understand that our government also plays a role in the marketplace.

Government usually plays a limited role in our market economy.

The role of the government will be discussed further in later lessons.

Government has three economic functions: efficiency, equity and stability.

In the efficiency function, the governments attempt to correct for market failures like monopolies.

In the equity function, the government uses a process such as income redistribution to assist the poor or handicapped.

In the stability function, the government attempts to keep the economy from being too high or too low.

In our present-day world, three principal economic systems compete with capitalism, the economic model of the United States. They are socialism, communism, and a market socialism.

Each of these has developed a model explaining the logic of its own system.

Each must, like capitalism, concern itself with scarcity and allocation of resources.

In a socialist economy, the basic problems of scarcity and allocation of limited resources are solved by production for use or need rather than production for profit.

The socialist theory believes that the basic economic questions should be answered by the government.

The socialist (communist) model was developed by Karl Marx. Marx was born in the German Rhineland in 1818, the son of a middle class family.

Marx saw history not as a meaningless succession of events but as a social change resulting from the struggle of classes.

Marx argued that all wealth is produced by labor, with the other factors of production either passive or also the result of labor.

In other words, the factors of land, capital, and management, could not exist or be used without the labor of the workers.

The factor of labor is what gives something its value.

Capitalists are able to accumulate large amounts of wealth because workers are not paid the full value of what they produce.

Surplus value, in the opinion of Marx, is the difference between what the workers produce and what they earn.

As this process continues, the middle class disappears and society becomes divided between capitalists (the people who take advantage of the workers) and the workers.

Most socialists theorized that economic and social progress should be made by peaceful evolution.

Marx believed the transition from capitalism to communism would follow a particular pattern and would be accompanied by a violent and bloody revolution.

The first stage is marked by the workers' overthrow of capitalism, (business owners) and is followed by the seizure of the government.

The second stage is characterized by the establishment of a small centralized authority that will govern in the name of the workers.

In the third stage, the dictatorship of the proletariat is replaced by the establishment of a "socialist" society. The political state will still exist, and because there may still be opposition, it will have considerable power. Economic production is to be controlled by the workers.

The fourth and highest stage is the true "communistic" society. Production will be in such abundance that work and payment will be made to everyone according to his/her need.

The communist economy seeks to end capitalism by revolution, whereas the socialists wish to do it through the ballot box. In the economic systems of socialism and communism, the government will have a large influence on the economy but will differ on the amount of freedom the people have to choose what they want to buy.

The communist political and economic theory of will be further explained in the lesson on Classical Theorists.

The basic issue both politically and economically is the degree of freedom allowed to the individual. In the chart we can see the complete political spectrum as it moves from left to right.

At the extreme left, we see the complete freedom of the individual with the absence of any governmental control. Such a condition, the absence of government, is called anarchy.

At the extreme right, citizens have lost their freedom to a totalitarian government that has complete control over every aspect of their lives. In an absolute monarchy there is rule by only one person.

In an oligarchy only a few people rule, whereas in a democracy the many rule. The political spectrum defines the extent of personal freedom the citizen has in relation to government authority.

In the above figure we see the economic spectrum. Here the difference lies in who decides the answers to the basic economic questions. What? How? and For whom?

Mixed capitalism, sometimes called welfare capitalism, favors decisions by consumers but allows for some central planning. As we move toward the left from mixed socialism to socialism to communism, central planning increases and reliance on the market mechanism declines.

At the extreme left, we see total central planning where the government makes almost all the decisions and consumers choices are given little attention.

Our economic spectrum is not complete unless we include the ownership of wealth. In the graphic below we see complete private ownership on one side and complete collective ownership on the other.

Although no countries have either of these extremes, classical capitalism calls for a maximum of private ownership and communism calls for a maximum of collective ownership, particularly of capital goods.

Again we see the different degrees of stress on ownership of wealth given by mixed capitalism, mixed socialism, and socialism.

Summary

Examples of these political and economic models will be described throughout all of the lessons.

You can consider both models as two new ECONOMIC APPLICATION TOOLS