topic 2 - basic economic decision

PSCI 1500: Introduction to

Economics

Basic Economics Decision

BASIC ECONOMIC DECISIONS

3 basic economic questions that determine the important decision regarding production & distribution.

1. What goods and services to produce and in what quantities?

2. How to produce these goods and services, or how to use the economy’s resources?

3. Who gets these goods and services (To whom)?

ECONOMIC SYSTEMS

Defined as an organized way in which a state or nation decide on utilizing the allocation of its resources, goods and services into the society.

Method or coordination by the state or nation to organize relationships among market players i.e. businesses, households, and government.

Among the economic systems, the most distinguishable - Agrarian (traditional) system, Planned system, Market system and Mixed system (the most relevant in modern day).

RELATIONSHIP : SCARCITY, BASIC ECONOMIC DECISIONS& ECONOMIC

SYSTEMS

AGRARIAN ECONOMIC SYSTEM

Also known as traditional or subsistence economy, favours equitable distribution of land.

Allocate a larger distribution of goods and services to those with a defined social status within the society.

Rely on historical, social, political, or religious arrangements or tradition for decision making.

Fairly small, close, and rural, and they often work to support all members.

AGRARIAN ECONOMIC SYSTEM

PLANNED ECONOMIC SYSTEM

Also known as socialism, communism, or command system

Rely on planning authority (central policy planner or a government) for all major economic decisions

Planning authority decides on what goods and services to be produced by the nation

Planning authority will instruct enterprises on how to produce various items.

Planning authority also decide who to get the goods and services

In a planned economy, most enterprise/business firms are owned by the central planning authority

PLANNING FAILURE

Planning failure or government failure refers to problem to the society or inability to achieve society’s goals which was created by the centralized planning system. Also known as non-market failure.

Government intervention can sometimes fail to meet objective, or make existing policy problems worse.


Examples of Government FailureDistortion of markets – i.e. minimum wage,

subsidies, shortages and surplusDisincentive effects – i.e. high taxes hamper

business expansion, welfare benefits reduce incentive to work

Short ‘termism’ – solving the ‘hot topics’ of the day rather than the long term important issues

Regulatory capture - regulatory agencies become dominated by the firms they are supposed to be regulating


The economic system where the people extensively engaged in free enterprise, in which is why market economies are often associated with capitalism.

Rooted in the belief that decisions are best made by individuals, thus private property rights are essential to this system (Adam Smith, The Wealth of Nations).

MARKET ECONOMIC SYSTEM

Also known as the price system as it utilized the pricing system for economic decision making.

Independent buyers & sellers (households & business) in the marketplace determine what to produce.

Businesses decide on the least-cost method of production.

Distribution (access to goods and services) is based on the ability to pay, which is determined by the resources that the people offer to businesses.


A pure market economy can best be illustrated by using the following Circular Flow Model.


COMPETITION & THE “INVISIBLE HAND”Competition is the mechanism of control for

the market system.It not only guarantees that industry responds

to consumer wants, but it also forces firms to adopt the most efficient production techniques.

Adam Smith wrote about the “invisible hand” which promotes public interest through a market system where the primary motivation is self-interest.

By attempting to maximize profits, firms will also be producing the goods and services most wanted by society.


MARKET FAILURE

Market failure refers to the situation where market system creates problem to society or fails to achieve society’s goals.

In any given market, the quantity of a product demanded does not equate to the quantity supplied, or situation where the market mechanism fails to allocate resources efficiently.


MARKET FAILURE

The social costs of producing the good or service (all of the opportunity costs of the input resources used in its creation) are not minimized, resulting in waste of some resources.

Market failure will eventually lead to the government intervention in the market.


Among the market failures are:

Imperfect information (ignorance on price, cost, benefits and long term value effects, etc.)

Oversupply of demerit goods and under-supply of merit goods

Market power leads to monopolyCertain services/goods would or could not be

provided in sufficient quantity by the marketExternalities due to existence of external

costs and benefits


Society frequently turns to the government to address market failure. Among the reasons government step in:

To correct shortages or surpluses in the marketTo provide what the market does not or can notTo regulate and correct inequality or inefficiency

To protect individuals and groups in society To provide a safetyTo reduce poverty

GOVERNMENT INTERVENTION IN MARKET ECONOMIES

How does government intervene?Taxation –provide incentive or disincentive

effectsSubsidies – to encourage

production/consumptionRegulation – guides, codes of practice,

legislation, Property rights –intellectual property,

patents, etc.Direct provision of goods / services – health,

education.


MIXED ECONOMIC SYSTEM

Refers to the economic system in which economic decisions are addressed by some combination of market and centralized decision making.

Pure market and pure planned economies are only used as the basis, but neither have real-world counterparts, and neither are perfect in their design.

As market economies experience problems, they tend to move away from pure market to mixed economies, and as planned economies experience failures, they move away from pure planned to mixed economies.

MIXED ECONOMIC SYSTEM

Continuum of Economic Decision Making

ISLAMIC ECONOMIC SYSTEM

Islamic Economic System belongs under the categories of a mixed economic system.

However, distinct characteristic is it operates within boundary of Shari’ah law and Islamic teaching based on Al-Qur’an & As-Sunnah.

Important characteristic of Islamic Economic System is the production of halal (Islamic permissibility) goods & services, the prohibition or condemnation of interest (riba) and the fiscal policy that levy zakat (Islamic tax) system as the basis of taxation.

THE ISLAMIC VIEW ON DISTRIBUTION OF WEALTH

Islamic economic system has a very distinguishable system for distribution of wealth. There are two kinds of people to have a right to wealth:

1. Those who have a primary right – those who have right to wealth directly in consequence of participation in the process of production. In other words, it is those “factors of production” which have taken part in the process of producing some kind of wealth.


THE ISLAMIC VIEW ON DISTRIBUTION OF WEALTH

2. Those who have a secondary right – those

who have not taken a direct part in the process of production, but charged upon the producers or the owners of factors of production to make them co-sharers in their wealth, principle is that wealth should not become concentrated in few hands.


topic 2 - basic economic decision

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