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Economic Systems and the Role of Government
Lecture 2


Economic Systems


  1. What is economics? - the study of choice under conditions of scarcity

    1. Economic system is an institutional arrangement

      1. Gov. specifies who owns property

      2. Who makes products

      3. Who gets to consume the products.

    2. Socialism – gov. owns and controls all society’s property, land, buildings, and machines.

      1. Gov. produces and distributes all goods and services to society

      2. Communism is the extreme form of socialism

      3. Also include a system where gov. maintains private property, but extensively uses taxes, subsidies, price controls, and regulations to control an economy.

    3. Laissez faire capitalism

      1. Laissez faire means leave it alone

      2. Citizens to own property, land, buildings, and machines.

      3. Citizens produce and distribute goods and services to other citizens.

      4. Synonymous with free markets.

        1. Free means minimal interference from government

        2. Market is where many private sellers and buyers meet

      5. Still need a government.

        1. Gov. establishes the legal structure

        2. “rules of the game”

    4. Graph socialism and capitalism

Scale for Government Control

    1. Index of Economic Freedom.- researchers try to rank how free people and businesses are.

      1. Free trade

      2. Levels of taxation

      3. Gov. expenditure

      4. Ease of obtaining licenses for a business, etc

      5. Note – "judgment"


Table 1. Two Indices of Economic Freedom

Country Heritage Foundation Heritage Foundation Heritage Foundation Gwartney & Lawson
2010 2008 2006 1998-1999
Hong Kong 1 1 1 1
Ireland 5 3 2 8
U.S.A. 8 5 9 3
Mexico 41 44 47 66
Kazakhstan 82 72 74 NA
Russia 143 134 129 119
Venezuela 174 148 152 100


Characteristics of Capitalism


  1. Private property rights – individual’s right to use, control, and obtain benefits from a good, service, or resource

    1. Foundation of capitalism

    2. Associated with equipment, land, and buildings

    3. Intangibles

      1. Patent – inventor has exclusive right to produce his invention for 17 years,

      2. Trademark – company’s logo or brand name

      3. Copyright – protects musicians and writers

  2. People maintain property

    1. Example – Soviet Union, the gov. owned all property

    2. People had no incentive to care for property

    3. stealing was rampant

  3. “Bundle of rights” – restrictions (regulations) on property

    1. Example – Zoning laws

      1. City gov. restricts areas to be industrial, commercial, or residential

      2. Person does not build a factory in a residential neighborhood

  4. Self interest directs activities of people and businesses.

    1. Consumers want cheap prices

    2. Entrepreneurs – assumes the risk of owning a business

      1. Wants to maximize profits

      2. Introduces innovative products

  5. Economic freedom

    1. Freedom of enterprise – firms are free to purchase resources to produce products and services.

    2. Freedom of choice – freedom to make economic choices

      1. Choose occupations, and products and services.

      2. Which products are produced

      3. Which employer to work for

    3. Voluntary exchange – selling goods among people

      1. Moves products to people who value them most

      2. Transactions costs

        1. Time

        2. Effort

        3. Information

        4. Taxes, fees ,etc to transfer product

        5. Transportation

      3. Transactions costs reduce gains from potential trades.

        1. Middleman – a person who buys, sells, or arranges trades.

          1. Reduces transactions costs.

          2. Car dealerships

          3. Grocery stores

          4. Stockbrokers

        2. Wealthy countries have more middlemen

  6. Economic freedom leads to specialization

      1. Division of labor breaks down the production of a good into specific tasks each performed by a different worker.

        • Mass-production technology

      2. Law of Comparative Advantage – countries specialize in production of goods where they have low costs relative to other countries

        1. United States grows corn and soybeans

        2. Columbia grows coffee

        3. Asia produces electronics

      3. Regions can specialize

        1. United States

          1. Texas – petroleum products

          2. Wisconsin – milk and cheese

          3. Florida – oranges

          4. Michigan – cars and trucks

        2. Companies can specialize in products and services.

          1. Microsoft – software

          2. Honda – cars and trucks

  7. Money also helps specialization

    1. Medium of exchange – allows people to pay for products and services using money.

    2. If society has no money, then it uses barter

      1. Barter – one product is traded for another

      2. Extremely inefficient

      3. Double coincidence of wants – for two people to engage in trade, they have to want the other person’s product

      4. If a person makes shoes and wants to buy bread, he has to find a person who makes bread and wants shoes

      5. Barter is making a comeback

        1. Internet reduces search time

        2. Business has cash flow problems

          • Uses barter to get resources to produce products

        3. Barter helps people avoid taxes

          • No value is placed on trade

Similarities and Difference between the Market and Government


  1. Criticism of capitalism

    • Karl Marx and Vladimir Lenin – 1st week

  2. Similarities between gov. and market

    1. Use cost-benefit analysis

      1. Before a firm, consumer, or government makes a decision on a future activity, the benefit of the activity should be greater than the costs.

        1. Thus, society obtains the most value from resources.

        2. Activity is efficiency

    2. Competition

      1. Market – sellers compete for the consumers.

      2. Gov. – gov. agencies compete for tax dollars

      3. Politicians compete for office.

    3. Limited resource

      1. Consumer income limits pending

      2. Business profits limit a firm’s growth

      3. Gov. spending is limited by taxes

        1. Gov. can borrow

        2. Gov. pays back with interest from future tax payments

  3. Difference between gov. and market

    1. Gov. creates legal structure

      • Everyone follows the rules

    2. Gov. uses force to modify human behavior

      1. Death penalty, incarceration, or seize property

      2. Impose fees, fines, and taxes, or subsidies

      3. Consumers and producers are more limited

    3. Market transactions are voluntary

      1. Even a monopoly – could choose to go without electricity

      2. Gov. forces everyone to pay taxes

    4. Gov. can redistribute wealth

      • Help pay for poor students to attend college

    5. Government is political

      • Democrats and Republicans


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