BACHELOR OF ARTS IN PUBLIC ADMINISTRATION PA 118 – Economic System and Public Administration...

BACHELOR OF ARTS IN PUBLIC ADMINISTRATION PA 118 – Economic System and Public Administration

Pangasinan State UniversitySocial Science – PSU Lingayen

CHAPTER 1ECONOMIC SYSTEM1st Semester, S.Y 2014–2015



A. Meaning of Economic SystemB. Economics vs. Public AdministrationC. Economic ActivitiesD. Fundamental Economic QuestionsE. Economic ResourcesF. Circular Flow Diagram: Three-Sector ModelG. Economic ModelsH. Economic Systems: Basic ComparisonI. Salient Functions of Economic SystemJ. Decision Making Structures of an EconomyK. Types of Economic System L. Traditional Economy M. Market Economy (Capitalism)N. Command Economy (Communism)O. Mixed Economy

Chapter Outline



Meaning of Economic System

Economic System is a particular set of institutional arrangements and a coordinating mechanism—to respond to the economizing problem. It is a society decides what goods to produce, how to produce them, and for whom goods will be produced.

An economic system is a set of economic institutions that provides the economic structure a given economy.



Economics deals with the proper allocation and efficient use of scarce resources to satisfy the unlimited wants of individuals.

Public Administration is concerned with the implementation of government policy (economic policies) and management of government programs.

Economics vs. Public Administration



Economic Activities

1. Production. The process of transforming inputs into outputs.

2. Distribution. The way total output, income, or wealth is distributed among individuals or among the factors of production

3. Exchange. The process of trading goods between buyers and sellers in a particular market.

4. Consumption. The process of how goods and services are utilized that give satisfaction to the consumers.



Economic System is the way in which a society decides what goods to produce, how to produce them, and for whom goods will be produced. Whether rich or poor, every nation must answer the same three fundamental economic questions:

1. What to produce?

2. How to produce?

3. For whom to produce?

Three Economic Questions



What to Produce?

To answer the first fundamental economic question, a society must decide the mix of goods and services it will produce. Will it produce mainly food, or will it also produce automobiles, televisions, computers, furniture, and shoes? The goods and services a society chooses to produce depend, in part, on the natural resources it possesses.

Because of scarcity, no country can produce every good it wants in the quantity it would like. More of one good (say, television sets) leaves fewer resources to produce other goods (such as cars). No matter what nation we are talking about—the United States, China, Japan, India, Russia, Cuba, or Brazil—each must decide what goods will be produced.



Consumption goods and services Goods and services that are bought by individuals

and used to provide personal enjoyment and contribute to a person’s quality of life.

Capital goods Goods that are bought by businesses to increase their

productive resources.

Government goods and services Goods and services that are bought by governments.

Export goods and services Goods and services that are produced in one country

and sold in other countries.

Categories of Goods and Services



How to Produce?

The next question every society has to answer deals with the ways in which people produce the goods. Will farmers using modern tractors produce food, or will farmers using primitive tools produce it? Will the food be produced on private farms, where production decisions are made by individual farmers, or will it be produced on collective farms, where production decisions are made by people in the government?

Answering this second question involves using scarce resources in the most efficient way to satisfy society’s wants. Again, decisions on methods of production are influenced, in part, by the natural resources society possesses.



Land It includes all the natural resources found in nature a country

possesses, such as water, minerals, animals, and forests.

Labor the work time and work effort that people devote to

producing goods and services.

Capital This refers to produced goods that can be used as resources

for further production.

Entrepreneurship human resource that com bines these factors of production

creatively and efficiently.

Economic Resources



Circular Flow Diagram: Three Sector Model



Households are individuals or groups of people living together and considered the consuming-unit of the economy. They sell economic resources, buy goods and services, pay taxes and receive transfer to the government.

Firms are the institutions that organize the production of goods and services and are considered the producing-unit of the economy. They buy economic resources, sell goods and services, pay taxes and receive subsidies from the government.

Government is a mechanism that determines the rules of the game in the economy. It buys goods and services and resources from firms and households, imposes taxes and provides transfers to households and firms

Components of the Circular-Flow Model:Households, Firms and Government



Market is a place or any arrangement that brings buyers and sellers together and enables them to get information and do business with each other. The circular flow model has two classifications of market.

Resource Market is a market in which a resource (land, labor and capital) is bought and sold.

Land market, capital market, labor market

Product Market is a market in which a good or service is bought and sold.

Components of the Circular-Flow Model:Resource Market and Product Market



Real Flows (input-output flows) depicts the flows of the economic resources (inputs) that go from households through resource markets to firms and of the goods and services that go from firms through goods markets to households.

Money Flows indicates the flows of payments made in exchange for the services of factors of production and of expenditures on goods and services.

Components of the Circular-Flow Model:Real Flows and Money Flows



When households choose the quantities of services of land, labor, capital, and entrepreneurship to offer in resource markets, they respond to the incomes they receive—rent for land, wages for labor, interest for capital, and profit for entrepreneurship. When firms choose the quantities of factor services to hire, they respond to the rent, wages, interest, and profits they must pay to households. Similarly, when firms choose the quantities of goods and services to produce and offer for sale in goods markets, they respond to the amounts that they receive from the expenditures that households make. And when households choose the quantities of goods and services to buy, they respond to the amounts they must pay to firms

Real Flows and Money Flows



For Whom to Produce?

This answers how goods and services are distributed among people in society. This actually involves two questions. Exactly how much should people get and how should their share be delivered to them? Should everyone get an equal share of the goods and services? Or should a person’s share be determined by how much he or she is willing to pay? Once the question of how much has been decided, societies must then decide exactly how they are going to get these goods to people. To do this, societies develop distribution systems, which include road and rail systems, seaports, airports, trains, ships, airplanes, computer networks—anything that helps move goods and services from producers to consumers in an efficient manner.



1. Economic efficiency

2. Economic growth and economic development

3. Economic freedom

4. Economic security

5. Equitable distribution of income

6. Full employment

7. Price level stability

8. Reasonable balance of trade

Economic Goals



An economic system is composed of two features: a mechanism for allocating resources and a mode of resource ownership.

Economic System



Economic Systems: Basic Comparison



Salient Functions of Economic System

1. To produce the goods for consumption of the population

2. To utilize the resources in efficient method of production

3. To employ the labor force in occupations where productivity is at optimum

4. To apportion the wealth and income available to everyone in an equitable manner

5. To encourage innovation and technology in order to maximize efficiency, optimize satisfaction and minimize waste



Decision-making structures of an Economy

The decision-making structures of an economy determine the use of economic inputs (the means of production), distribution of output, the level of centralization in decision-making, and who makes these decisions. Decisions might be carried out by industrial councils, by a government agency, or by private owners. Some aspects of these structures include:

1. Coordination mechanism. How information is obtained and used to coordinate economic activity. The two dominant forms of coordination include planning and the market; planning can be either centralized or de-centralized, and the two mechanisms are not mutually exclusive.



Decision-making structures of an Economy

2. Productive property rights. This refers to ownership (rights to the proceeds of output generated) and control over the use of the means of production. They may be owned privately, by the state, by those who use it, or held in common by society.

3. Incentive system. A mechanism for inducing certain economic agents to engage in productive activity; it can be based on either material reward (compensation) or moral reward (social prestige).



1. Traditional Economy

2. Market Economy (Capitalism)

3. Command Economy (Communism)

4. Mixed Economy

Types of Economic System



Traditional economy is an economic system in

which people make economic decisions based on customs and beliefs that have been handed down from generation to generation.

Resources are allocated according to long-lived practices from the past.

The society produces what best ensures its survival.

Examples: Caste system in India, Kavango people of Namibia

Traditional Economy



Market economy is characterized by the private ownership of resources and the use of a system of markets and prices to coordinate and direct economic activity.

Private individuals own most, if not all, the resources and control their use.

The prices of goods and services are determined in a free price system.

Market Economy



Market Economy

According to Adam Smith (1723–1790), market forces allocate resources as if by an “invisible hand”—an unseen force that harnesses the pursuit of self-interest to direct resources where they earn the greatest reward. According to Smith, although each individual pursues his or her self-interest, the “invisible hand” of market forces promotes the general welfare. Capitalism or market economy is sometimes called laissez-faire; translated from the French, this phrase means “to let do,” or to let people do as they choose without government intervention. Thus, under capitalism, voluntary choices based on rational self-interest are made in unrestricted markets to answer the questions what, how, and for whom.



Characteristics and Features of a Free Enterprise Economy

1. Private Property

2. Freedom of Enterprise or Choice

3. Self-interest

4. Competition

5. Markets and Prices

6. Economic Incentives

7. Technology and Capital Goods

8. Specialization

9. Use of Money

10.Active, but Limited, Government



Private Property

In a market system, private individuals and firms, not the government, own most of the property resources (land and capital). It is this extensive private ownership of capital that gives capitalism its name. This right of private property, coupled with the freedom to negotiate binding legal contracts, enables individuals and businesses to obtain, use, and dispose of property resources as they see fit. The right of property owners to designate who will receive their property when they die helps sustain the institutionof private property.



Freedom of Enterprise or Choice

Freedom of enterprise ensures that entrepreneurs and private businesses are free to obtain and use economic reources to produce their choice of goods and services and to sell them in their chosen markets.

Freedom of choice enables owners to employ or dispose of their property and money as they see fit. It also allows workers to try to enter any line of work for which they are qualified. Finally, it ensures that consumers are free to buy the goods and services that best satisfy their wants and that their budgets allow.

The market system requires that various economic units make certain choices, which are expressed and implemented in the economy’s markets:



Self-interest

In the market economy, self-interest is the motivating force of the various economic units as they express their free choices. Self-interest simply means that each economic unit tries to achieve its own particular goal, which usually requires delivering something of value to others. Entrepreneurs try to maximize profit or minimize loss. Property owners try to get the highest price for the sale or rent of their resources. Workers try to maximize their utility (satisfaction) by finding jobs that offer the best combination of wages, hours, fringe benefits, and working conditions. Consumers try to obtain the products they want at the lowest possible price and apportion their expenditures to maximize

their utility.



Markets and Prices

The coordinating mechanism of capitalism is a system of markets and prices. A market is an institution or mechanism that brings buyers (“demanders”) and sellers (“suppliers”) into contact. A market system conveys the decisions made by buyers and sellers of products and resources. The decisions made on each side of the market determine a set of product and resource prices that guide resource owners, entrepreneurs, and consumers as they make and revise their choices and pursue their self-interest.



Economic Incentives

An incentive is something that encourages or motivates a person toward action. Under free enterprise, money acts as an incentive to produce. If you produce goods and services that people are willing and able to buy, you receive money in return. Adam Smith wrote about the usefulness of economic (or monetary) incentives in a free enterprise economy. He explained that business owners are interested in making themselves better off. This desire to earn an income strongly motivates them to produce for others.



Competition

The market economy depends on competition among economic units. The basis of this competition is freedom of choice exercised in pursuit of a monetary return. Very broadly defined, competition requires:

• Two or more buyers and two or more sellers acting independently in a particular product or resource market. (Usually there are many more than two buyers or sellers.)

• Freedom of sellers and buyers to enter or leave markets, on the basis of their economic self-interest.



Technology and Capital Goods

In the market system, competition, freedom of choice, self-interest, and personal reward provide the opportunity an motivation for technological advance. The monetary rewards for new products or production techniques accrue directly to the innovator. The market system therefore encourages extensive use and rapid development of complex capital goods: tools, machinery, large-scale factories, and facilities for storage, communication, transportation, and marketing. Advanced technology and capital goods are important because the most direct methods of production are often the least efficient. The only way to avoid that inefficiency is to rely on capital goods.



Specialization

The extent to which market economies rely on specialization is extraordinary. Specialization is the use of resources of an individual, firm, region, or nation to produce one or a few goods or services rather than the entire range of goods and services. Those goods and services are then exchanged for a full range of desired products. The majority of consumers produce virtually none of the goods and services they consume, and they consume little or nothing of the items they produce.

Human specialization (Division of labor) Geographic specialization (International trade)



Use of Money

A rather obvious characteristic of any economic system is the extensive use of money. Money performs several functions, but first and foremost it is a medium of exchange. It makes trade easier.

Functions of Money

Medium of exchange Unit of account Store value Standard of deferred payment



Active, but Limited, Government

An active, but limited, government is the final characteristicof market systems in modern advanced industrial economies. Although a market system promotes a high degree of efficiency in the use of its resources, it has certain inherent shortcomings, called “market failures.” This includes:

• Monopolies• Public Goods• Externalities• Bounded Rationalities• Information Asymmetry• Property Rights as Right of Control



Some Advantages of a Market Economy)

1. Goods and services go where they are most in demand and free market responds quickly to people’s wants plus wide variety of goods and services.

2. No need for and overriding authority to determine allocation of goods & services.

3. Producers and consumers are free to make changes to suit their aims.

4. Competition and the opportunity to make large profits, greater efficiency, innovation



Flaws of Market Economy

1. No central authority protects property rights, enforces contracts, and otherwise ensures that the rules of the game are followed.

2. People with no resources to sell could starve.3. Some producers may try to monopolize markets by

eliminating the competition.4. The production or consumption of some goods involves side

effects that can harm or benefit people not involved in the market transaction.

5. Private firms have no incentive to produce so-called public goods, such as national defense, bec. private firms cannot prevent nonpayers from enjoying the benefits of public goods.

In practice, market economy has its flaws. The most notable market failures are:



Some Disadvantages of a Market Economy)

1. It misallocates resources to those with more

money

2. It creates inequality of incomes

3. It is not competent in providing certain services

4. It leads to inefficiency (market imperfection)

5. It can encourage the consumption of harmful

goods



an economy characterized by public ownership of virtually all property resources and the rendering of economic decisions through central economic planning.

Government owns most of the businesses and makes all economic decisions.

There is no free competition because the government is the only seller.

Countries using mainly the command system include Turkmenistan, Laos, Belarus, Libya, Myanmar, Iran, North Korea and the former Soviet Union.

Command Economy



Command Economy

Command economies are disappearing fast. Until a few years ago, examples would have included the former Soviet Union, Poland, Rumania, Bulgaria, Albania, and many others. Beginning in the late 1980s, all of these nations have abandoned central planning. The only examples left are Cuba, China, and North Korea, and even these economies—though still dominated by central planning— are moving away from it.

Other countries using mainly the command system include Turkmenistan, Laos, Belarus, Libya, Myanmar, and Iran, North Korea, Russia



Command Economy

An economic system characterized by the public ownership of resources and centralized planning. In this system, government owns most property resources and economic decision making occurs through a central economic plan

A central planning board appointed by the government makes nearly all the major decisions concerning the use of resources, the composition and distribution of output, and the organization of production

The government owns most of the business firms, which produce according to government directives. The central planning board determines production goals for each enterprise and specifies the amount of resources to be allocated to each enterprise so that it can reach its production goals.



Mixed Economy is a blend of market system and some form of government regulation and control. Private ownership of resources exists side by side with substantial public ownership of resources and government participation in economic activities.

This involves a degree of private economic freedom mixed with a degree of government regulation of markets.

The major and strategic industries are owned and managed by the state while the minor industries belong to the private sector.

Mixed Economy



Elements of a Mixed Economy

The elements of a mixed economy have been demonstrated to include a variety of freedoms:

1. to possess means of production (farms, factories, stores, etc.)

2. to participate in managerial decisions (cooperative and participatory economics)

3. to travel (needed to transport all the items in commerce, to make deals in person, for workers and owners to go to where needed)

4. to buy (items for personal use, for resale; buy whole enterprises to make the organization that creates wealth a form of wealth itself)

5. to sell (same as buy)



Flaws of Command Economy

1. Running an economy is so complicated that some resources are used inefficiently.

2. Because nobody in particular owns resources, each person has less incentive to employ them in their highest-valued use, so some resources are wasted.

3. Central plans may reflect more the preferences of central planners than those of society.

4. Because government is responsible for all production, the variety of products tends to be more limited than in a capitalist economy.

5. Each individual has less personal freedom in making economic choices.

In practice, the pure command system also has flaws, most notably:



Elements of a Mixed Economy

6. to hire (to create organizations that create wealth)7. to fire (to maintain organizations that create wealth)8. to organize (private enterprise for profit, labor unions,

workers' and professional associations, non-profit groups, religions, etc.)

9. to communicate (free speech, newspapers, books, advertisements, make deals, create business partners, create markets)

10. to protest peacefully (marches, petitions, sue the government, make laws friendly to profit making and workers alike, remove pointless inefficiencies to maximize wealth creation)

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