Chap18 Fundamental Economic Concepts

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  • The freedom to use

    your own tools and

    labor in pursuit of profits is one

    of the primary features of

    capitalism. In Chapter 18, you

    will learn that capitalism is more

    than an ideology. It is the way

    we live and the way the world is

    headed. To learn more about

    the different systems of

    economics, view the Chapter 25

    video lesson:

    Comparative Economic Systems

    Chapter Overview Visit the Economics: Principlesand Practices Web site at andclick on Chapter 18Chapter Overviews to pre-view chapter information.

    This scene of the city of Jaipur innorthwest India shows a blendof traditional and modern life.

  • The Spectrum of Economic Systems

    Main IdeaCapitalism, socialism, and communism are historicallythree popular economic systems.

    Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below by list-ing six advantages of capitalism and providing anexample of each.

    Key Termscapitalism, socialism, communism

    ObjectivesAfter studying this section, you will be able to:1. Explain the advantages and disadvantages of

    capitalism.2. Describe the differences among the doctrines

    of socialism, capitalism, and communism.3. Compare the features of communism to other

    types of economic systems.

    Applying Economic ConceptsSurplus Value Have you ever felt that the value ofyour work was much more than your wage? If so, youhave something in common with Karl Marx, whofounded communism and introduced the concept ofsurplus value that is extracted from labor.

    Cover Story

    Sweden Pays the Price of High Taxes


    AB, the big Swedish appliance

    maker, scoured the globe for a

    person to set up a new data-

    processing division last year before finding Stephan

    Carlquist, a Swede and senior executive at ABB Asea

    Brown Boveri in the United States.

    Persuading him to jump to Electrolux was no

    problem, but bringing him to Sweden, home of the

    industrialized worlds highest tax rates, was another

    matter. Instead, Mr. Carlquist set up shop in London,

    where taxes are lighter. . . .

    Over the next year, he plans to build a multina-

    tional team of as many as 50 peoplefew of them

    Swedes. . . . Its very hard to attract skilled, interna-

    tional people to Sweden. Mr. Carlquist said.

    International Herald Tribune, March 16, 1999

    Stephan Carlquist

    T hroughout most of the 1900s, the worldsdeveloped nations fell into three categoriesof economic systemscommunism, social-ism, and capitalism. Communist countries wereclosely associated with command economies, capi-talist countries were most similar to marketeconomies, and socialist countries had a combina-tion of both command and market economies.Sweden is an example of a country with a strongsocialist tradition, andas you read in the coverstorythe high taxes that go along with it.

    The three basic types of economic systems areshown in Figure 18.1. At the far left is communism,in which a strong central government influencesalmost every economic decision. At the far right iscapitalism, in which government has a limited role.As one moves from left to right along the spectrum,both the ownership of resources and the degree ofgovernment involvement in the operation of theeconomy change.

    CapitalismAdvantages Examples


  • No lines separate communism, socialism, andcapitalism. They appear on the spectrum as havinga greater or lesser degree of government involve-ment and private ownership of resources.

    CapitalismUnder capitalism, the means of productionare privately owned. Supply and demand

    determine prices, and businesses are free to directresources into activities that promise the greatestprofits.

    Advantages of CapitalismOne of the main advantages is efficiency. If there

    are many buyers and sellers, if resources are reason-ably mobile, and if buyers and sellers are reasonablywell informed, then resources will be directed totheir most profitable and efficient use.

    Another advantage is freedom, which gives con-sumers the opportunity to purchase the goods andservices that best satisfy their preferences. Producersalso have the freedom to direct productive resourcesinto activities that consumers demand most.Producers have the incentive to do so because of theprofit motive, and because private property rightsallow them to keep the fruits of their efforts.

    A third advantage is that capitalism is highlydecentralized. Consumers and producers jointlyanswer the WHAT, HOW, and FOR WHOMquestions all societies face. This is made possiblebecause of the price system, which sends signals toboth producers and consumers. The decentralizednature of decision making leads to the fourthadvantage. Specifically, the role of government inthe economy is much smaller.

    The fifth advantage is the high degree of con-sumer satisfaction that comes from the variety ofproducts that are produced to satisfy consumerdemands. The sixth advantage is the flexibility toaccommodate change. When consumer preferenceschange, or when the price of resources changes, sig-nals are sent through the price system and everyoneadjusts accordingly.

    The most visible result of these advantages isthe enormous amount of wealth that capitalistnations have accumulated. With few exceptions,

    the countries that have the highest living standardsand per-capita incomes today are ones with market-based capitalist economies.

    Disadvantages of Capitalism Capitalism has its disadvantages. Although it is

    efficient in satisfying the demands of consumers, itdoes not always satisfy everyones needs. At a collec-tive level, capitalism ignores the production of manypublic goods such as roads, public schools, a systemof justice, and national defense. Instead, the marketproduces private goods and servicesitems that canbe withheld if people refuse to pay for them.

    At an individual level, capitalism produces onlyfor those who have demand, which means the abil-ity and willingness to pay. A system of pure capital-ism would ignore poor people, the unemployed, andless productive members of society like the elderly.

    Socialism Socialism is an economic system in whichgovernment owns and runs some of the

    basic productive resources in order to distributeoutput in ways deemed to be in the best interestof society. Most socialist societies are democraciesin which elected officials direct the allocation ofresources in key industries.

    Advantages of Socialism Socialism addresses the FOR WHOM question

    directly. Those who are not fortunate or productiveenough to earn a competitive income still share inthe benefits of society. Although the governmentowns the majority of productive resources in asocialist society, people use their electoral power toinfluence many of the WHAT, HOW, and FORWHOM questions.

    Disadvantages of Socialism Socialism is normally less efficient than capital-

    ism. If workers receive government guarantees ofjobs, more workers will be hired than are neces-sary, driving up the cost of production. The


  • government also has an incentive to keep theseworkers employedeven if they are not allneededto show that the government is providingjobs for everyone.

    Because the government provides a broaderrange of services such as health care, education,and welfare, taxes are generally higher in socialistcountries. This often causes the type of labormobility problems discussed in the cover storywhere workers may be reluctant to work in coun-tries with such high taxes.

    Communism In its purest form, communism is a politicaland an economic framework where all prop-

    erty is collectively owned, labor is organized forthe common advantage of the community, andeveryone consumes according to their needs.

    To date, no modern country has achieved theideal of pure communism. Countries such as Cuba,North Korea, and the former Soviet Union insteaddeveloped rigid command-type economies where

    E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E Figure 18.1Figure 18.1

    Using Charts Using Charts The distinguishing feature of economic systems is the ownership of the factors of production and the role of government in deciding WHAT, HOW, and FOR WHOM to produce. How is capital for production acquired under capitalism?

    The Spectrum of Economic Systems

    Ownership of ResourcesAll productiveresources are

    government ownedand operated.

    Directed by Command Directed by the Free Market

    Productive resourcesare privately

    owned and operated.

    Allocation of Resources

    Centralizedplanning directs

    all resources.

    Government plans waysto allocate resources in

    key industries.

    Capital for production isobtained through the lureof profits in the market.

    Role of Government

    Government makesall economicdecisions.

    Government directs thecompletion of its economic

    plans in key industries.

    Government maypromote competition and

    provide public goods.


    Basic productive resourcesare government owned and

    operated; the rest are privatelyowned and operated.


  • Checking for Understanding 1. Main Idea Identify the three broad economic

    systems of the last century.

    2. Key Terms Define capitalism, socialism, communism.

    3. List the advantages and disadvantages of capitalism.

    4. Explain how capitalism, socialism, and com-munism are different.

    5. Describe how communism differs from othertypes