02 Micro Lecture 2 - Economics System

2007 Thomson South-Western, all rights reserved
Last Updated:27 October 2014

LMS SEGi education group
0
BDB1373 (DIBA/ DIM/ DIA)

Lecture 2
- Economics Systems
Learning Objectives
Students will able to learn :
the economic questions
the characteristics of free market, command
economy and mixed
the advantages and disadvantages of free
market
the advantages and disadvantages of
command economy
how the economic systems answer the basic
economic questions


1
Economic System
Economic System
is a set of
mechanisms and
institutions that
resolve the
_______, ______,
and ________
questions


2
Types of Economic Systems
The market economy

The command economy

The mixed economy


3
Characteristics of Capitalism
Price Mechanism
It means the free operation of demand and
supply forces without any government
intervention.
All economic processes such as
consumption, production, savings,
investment will according to price
mechanism (let people do as they choose
without government intervention) and is
labelled as invisible hand by Adam Smith


4
Private Ownership
Private ownership of resources.
Every individual has a right to
acquire private ownership of
resources.
Private individuals can
accumulate property and use it
as they choose.
Example : If Amin wants to buy
a bungalow, he can purchase
the property if he has sufficient
money. There is no restriction
on the number of properties
Amin can own.


5
Role of Interest
Individuals are free to
make choices.
Customers would
maximize their satisfaction.
Businessmen are
motivated by profits. They
produce in order to
maximize profits.


6
Consumer is said to be the king.
Consumers decisions
would influence the
producers decisions of
what to produce.
Producers have to produce
goods and services to meet
customers tastes and
preferences, otherwise they
will not be able to sell what
they produce.


7
Presence of Competition
Competition is healthy as it
encourages research and
development.
Invention and innovation are
made possible with science
and technology. With the
existence of such elements,
economic growth can be
achieved.
Producers will keep improving
their techniques of production
in order to compete with other
firms.

8
Limited government intervention
Limited government
intervention in the
economic activities of the
economy.
All economic activities are
carried out by the private
sector.
For example : television
stations and telephone
services.


9


10


11


12
Advantages : Economic Freedom
Economic freedom means the
right to earn property.
It also means a freedom of
enterprise and a choice of
occupations.
This will lead to the sourcing of
the countrys manpower from
different sectors.
Therefore, a flexible functioning
of different units of production.


13
Production according to the
need of consumers
Producers produce goods and services
that consumers want and this maximizes
the needs and satisfaction of consumers.


14
Efficient utilization of resources
Competition creates efficiency in
production.
Quality goods are produced at lower cost.
Consumers get the highest quality goods
at a lower cost since production
techniques are more efficient.


15
Variety of Consumer Goods
Competition takes place with regard to all
aspects of the product such as shape,
quality, colour, design and packaging.
Therefore, consumers will enjoy a wide
variety of the same product.
There is also a variety of consumer goods
because of freedom of enterprise,
resulting in greater production.


16
Enhanced trade, business,
research and development
Producers are always on the lookout for
new innovations to compete with other
producers.
This will lead to a rapid expansion and an
increase in employment and income.
Innovators enjoy the benefits of their
research through copyright and patents.


17
Automatic incentives
Capitalism provides encouragement to
efficient producers.

Efficient producers will benefit from the
price mechanism as compared to
inefficient producers.


18
Flaws in Capitalism

No central authority to protect property
rights, and enforce contracts.
Some producers may try to monopolize by
eliminating the competition.
So-called public goods, such as national
defense, will not be produced by private
firms because they cannot prevent non-
payers from enjoying the benefits of public
goods.


19
Disadvantages : Unequal distribution of
income and wealth

Since there is no government
intervention in the market, the
system of private property
widens the gap between the
rich and the poor.
Those who have wealth can
obtain resources and start
businesses while the poor only
have their labor to offer.
In other words, the rich get
richer and the poor get poorer.


20
Inflation and high unemployment
rate
Since it is governed by the invisible
hand, business fluctuations cause high
unemployment rates during depression.


21
Lack of social welfare
In free economy, social welfare is
ignored.
Owners do not provide any
pension, social security or
accident benefits to employees.
There is also insufficient provision
of public facilities such as
schools, hospitals and etc.
Undesirable social effects such
as theft and crime tend to be
high.


22
Misallocation of resources
A producers objective is to maximize profit
and he will therefore, only produce
products which give higher profits.
This will lead to the production of luxury
goods (for rich people), resulting in a
surplus and a lack of production of goods
for the poor.


23
Social Costs
Workers may face social problems such
as health problems arising from the
polluted environment caused by an
improper disposal of factory wastes.
The intention of most producers is to
increase private profit and this often leads
to a neglect in the welfare of their workers.


24
Mao Zedong
Vladimir Ilyich Lenin


25
Characteristics of Pure Command
System
Public ownership of resources
All the resources are owned and operated
by the state or the government in the
interest of society as a whole.
This is to ensure equal opportunity of all
citizens regardless of their income.
Public ownership also aims to fully utilize
the countrys resources and maximize
social welfare.


26
Central Planning
The central authority is responsible for
making economic decisions for society.
The authority plans and allocates
resources between current consumption
and investment for the future.


27
Price mechanism of lesser
importance
Socialism gives less importance to market
forces.
Prices are fixed by the government and
not determined by demand and supply.
Private profits are not allowed and public
interest is emphasized in the command
economy.


28
Command Economies: Advantages
Abundant provision of collective goods (e.g.
education, health, public transport and
recreational facilities)


29
Production according to basic
needs
Production is directed at producing the
basic needs of the people such as food,
clothing and building materials.
It is not determined by the purchasing
power of the rich in society.
The phenomenon of the rich getting richer
and the poor getting poorer does not exist
in the socialist economy.


30
Equal distribution of income and
wealth
This system provides
equal opportunities for all
citizens in earning an
income.


31
No serious unemployment or
inflation
The unemployment rate and inflation are
usually taken care of by the government to
ensure economic stability in the country.


32
Social Welfare
The government will provide all citizens of
the country with full social security benefits
such as pension, accident benefits and
wastage of resources do not exist in a
socialism system.


33
Flaws of Command System
Running an economy is so complicated that
some resources are used inefficiently.
Since nobody owns resources, people have less
incentive to employ them in their highest valued
use.
Central plans may reflect more the preferences of
central planners than those of society.
Since government is responsible for all
production, the variety of products tends to be
more limited than in a market economy.
Each individual has less personal freedom in
making economic choices.


34
Absence of competition
Since there are limited private enterprises,
less research and development activities
are carried out.
This results in low quality products since
there is no competition.


35


36
Mixed Economy
This is an economic system which
combines both capitalism and socialism to
solve basic economic problems.
A mixed economy is an economy in which
both the public and private sectors play a
role in the economy.


37
Public and Private Ownership of
resources
Private enterprises conduct business
freely.

Government encourages the private sector
by providing them with infrastructure and
facilities.


38
Price mechanism and economic
plans in making economic decisions
The price mechanism is used to price both
goods and services.
However commodities such as sugar,oil
and rice are declared as controlled items
in Malaysia and the government fixes their
prices.
Most of the mixed economies accept
economic planning as an instrument of
economic growth.


39
Command Economy

1. What? One person or a group of people (often
government officials) decide what products are
needed. In most cases, their decisions are dictated by
what they believe is important.

2. How? Since the government owns all the means of
production in a command economy, the government
runs all the businesses. It decides how goods and
services will be produced. It employs all workers and
controls all employment opportunities.

3. For whom? The government decides who will get
what is produced. In principle, all the people share
equally in the nation's wealth. In that way, everyone's
basic needs are met. There is much security in such a
system-but at the cost of individual freedom.


40
Government helps to control
income inequality
In most mixed economies, the government
controls income inequality through income
taxes and welfare payments.
The government helps to narrow the
income gap between rich and the poor.


41
Government intervention in the
economy
The government will not intervene in the
economy except for particular industries.
In a mixed economy, the government uses
legislation for unsafe goods categorized as
illegal products such as military items.
The government also uses direct provision such
as education, defense and health to increase the
standard of living.
The government caters projects that are
considered as unprofitable for the private sector.
Example : low cost housing projects.


42
Government control of
monopolies
Monopolists are single players in an
industry.
They have complete, sole control over the
price of goods or services.
In order to avoid customers being
exploited by monopolists, the government
will regulate the power of monopolists.


43
Market Economy

1.What? Consumers decide what should be produced in a market
economy. They do this through the purchases they make in the
marketplace. Only those items that satisfy consumer's needs and
wants are purchased, so only those products succeed. Products that
do not satisfy consumer's needs and wants are not purchased and so
fail.

2. How? How products will be produced is left up to businesses in a
market economy. In such an economy, businesses must be
competitive. They must produce quality products at lower prices than
their competitors. To do that, they must try to find the most efficient way
to use available resources when producing their goods and services.

3. For Whom? In a market econony, the people who have more
money are able to buy more goods and services. To obtain money,
people are motivated to work and invest the money they make.


44
Learning Materials:
Main Text :

Robert Pindyck & Rubinfeld. D (2008). Microeconomics. Prentice
Hall

References :

Mankiw,G.N.(2008). Principles of Economics fifth edition, South
Western Cengage Learning.
Parkin, M (2008). Economics 8th edition, Pearson International
Edition.
Sloman, J. (2008). Economics, Harlow: Financial Times/Prentice Hall
Deviga,V.,Karunagaran, M.(2008). Principles of Economics,Oxford
Fajar Sdn.Bhd.


45

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2007 Thomson South-Western, all rights reserved

Last Updated:27 October 2014

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