Learning Objectives
By the end of this section, you will be able to do the following:- Contrast traditional economies, command economies, and market economies
- Explain gross domestic product (GDP)
- Assess the importance and effects of globalization
Think about what a complex system a modern economy is. It includes all production of goods and services, all buying and selling, all employment. In addition, the modern economy answers the basic economic questions: What goods and services should be produced, how should they be produced, and to whom should they be distributed? The economic life of every individual is interrelated, at least to a small extent, with the economic lives of thousands or even millions of other individuals. Who organizes and coordinates this system? Who insures that, for example, the number of televisions a society provides is the same as the amount it needs and wants? Who insures that the right number of employees work in the electronics industry? Who insures that televisions are produced in the best way possible? How does it all get done?
There are at least three ways societies have found to organize an economy and answer the basic economic questions. The first is the traditional economy, the oldest economic system to answer the basic economic questions. This economy can be found in parts of Asia, Africa, and South America. Traditional economies organize their economic affairs the way they have always done (i.e., tradition). Occupations stay in the family. Most families are farmers who grow the crops they have always grown using traditional methods. What you produce is what you get to consume. Because things are driven by tradition, there is little economic progress or development.
Command economies are very different. In a command economy, economic effort is devoted to goals passed down from a ruler or ruling class. Ancient Egypt was a good example: A large part of economic life was devoted to building pyramids, like those shown in Figure 1.7, for the pharaohs. Medieval manor life is another example: The lord provided the land for growing crops and protection in the event of war. In return, vassals provided labor and soldiers to do the lord’s bidding. In the last century, communism emphasized command economies.
In a command economy, the government decides what goods and services will be produced and what prices will be charged for them. The government decides what methods of production will be used and how much workers will be paid. Many necessities like healthcare and education are provided for free. Currently, Cuba and North Korea have command economies.
Although command economies have a very centralized structure for economic decisions, market economies have a very decentralized structure. A market is an institution that brings together buyers and sellers of goods or services, who may be either individuals or businesses. The New York Stock Exchange, shown in Figure 1.8, is a prime example of market in which buyers and sellers are brought together. In a market economy, decision-making is decentralized. Market economies are based on private enterprise. The means of production (resources and businesses) are owned and operated by private individuals or groups of private individuals. Businesses supply goods and services based on demand. In a command economy, by contrast, resources and businesses are owned by the government. In a market economy, what goods and services are supplied depends on what is demanded. A person’s income is based on his or her ability to convert resources (especially labor) into something that society values. The more society values the person’s output, the higher the income (think Lady Gaga or LeBron James). In this scenario, economic decisions are determined by market forces, not governments.
Most economies in the real world are mixed; they combine elements of command and market (and even traditional) systems. The U.S. economy is positioned toward the market-oriented end of the spectrum. Many countries in Europe and Latin America, while primarily market-oriented, have a greater degree of government involvement in economic decisions than the U.S. China and Russia, while they are closer to having a market-oriented system now than several decades ago, remain closer to the command economy end of the spectrum. A rich resource of information about countries and their economies can be found on the Heritage Foundation’s website, as the following Clear It Up feature discusses.
Clear It Up
What Countries are Considered Economically Free?
Who is in control of economic decisions? Are people free to do what they want and to work where they want? Are businesses free to produce when they want and what they choose, and to hire and fire as they wish? Are banks free to choose who will receive loans? Or does the government control these kinds of choices? Each year, researchers at the Heritage Foundation and The Wall Street Journal look at 50 different categories of economic freedom for countries around the world. They give each nation a score based on the extent of economic freedom in each category.
The 2015 Heritage Foundation’s Index of Economic Freedom report ranked 178 countries around the world: Some examples of the most free and the least free countries are listed in Table 1.1. Several countries were not ranked because of extreme instability that made judgments about economic freedom impossible. These countries include Afghanistan, Iraq, Syria, and Somalia.
The assigned rankings are inevitably based on estimates, yet even these rough measures can be useful for discerning trends. In 2015, 101 of the 178 included countries shifted toward greater economic freedom, although 77 of the countries shifted toward less economic freedom. In recent decades, the overall trend has been a higher level of economic freedom around the world.
Most Economic Freedom | Least Economic Freedom |
---|---|
1. Hong Kong | 167. Timor-Leste |
2. Singapore | 168. Democratic Republic of Congo |
3. New Zealand | 169. Argentina |
4. Australia | 170. Republic of Congo |
5. Switzerland | 171. Iran |
6. Canada | 172. Turkmenistan |
7. Chile | 173. Equatorial Guinea |
8. Estonia | 174. Eritrea |
9. Ireland | 175. Zimbabwe |
10. Mauritius | 176. Venezuela |
11. Denmark | 177. Cuba |
12. United States | 178. North Korea |