Alternative Economic Systems

It should not surprise that over the centuries many solutions to the basic economic problems have been tried and that each solution is unique. The economic system in ancient Greece was different from the current system in the US which is substantially different from the system in China. Rather than focusing on the differences in the myriad of economic systems that have existed, however, we will focus our attention on similarities and discuss three major types - Traditional, Command, and Market Systems.

The differences between the systems is readily apparent when we look at your careers - how you find yourself in the MBA program and others do not. One approach to allocating the limited number of "university slots" would be to allocate them the way they had always been allocated. If your parents got an MBA, then you would go to college: if your father was an engineer, then you would be an engineer.  Scarce resources would be allocated as they had always been - by Tradition.

A alternative approach would have been to have some "BIG BOSS" make the decisions on who would get the MBA.  For this system to run we would need a modern day Pharaoh or Czar with the power to decide how many MBAs are needed, who they should be, and where they should work.  In this world scarce resources would be allocated by Command.

And then there is the system in which you chose to be an MBA student.  Regardless of the reason, you have chosen the MBA route.

Now imagine an entire system in which scarce resources would be allocated by the choices of individuals. For this system to be effective, decision makers such as you need both the information necessary to make informed choices and the incentive to make those choices. One such system would be the market system which provides the information in the form of prices, and incentives in the form of property rights which enables the owners of property to use the property and to sell it. Getting back to the career choice problem, you have decided to be an engineer because the price (income) was right and with your new wealth you would be able to obtain those things which mattered most to you.

The analysis of this choice of career, as well as the choice of someone to teach you economics, would be the subject matter of Microeconomics where the emphasis is on individual choice.  Here the focus is on the explanation of  choices made by individuals and firms - how many hours to work, how many children to have, how much output to produce, and how many workers to employ. The basic premise in microeconomics is that firms are pursuing profit while individuals / households are pursuing their self interest.   As you will hear me say many times, we look at decision makers as calculators continuously weighing the costs against benefits associated with any decision/choice.  

Once we accept this perspective,  it becomes clear why economists tend to focus their attention on costs. Three cost concepts which we will discuss during the semester will be sunk / fixed costs, marginal costs, and opportunity cost. An understanding these concepts is necessary if we are to understand rational choices - the choices that decision makers make to improve their position.

But how do we avoid chaos when all decision makers are pursuing their self interest? The "secret" is in the interaction between the individual decision makers. The nature of the interaction can be seen below in a very simple version of the Circular Flow Diagram which identifies the three major aggregate markets (output, capital, and labor) which tend to bind the decision makers (households, firms, and government) together.  Households / individuals buy goods and services in the output market, sell labor in the labor market, and borrow money (mortgages, car loan) and lend money (savings account, mutual fund) in the capital market.

In the case of a career choice, the logic of the system would go something like this. In the output market we find evidence people want computers which sends a signal (profits) to firms which prompts them to raise production levels.  This generates a need for more electrical engineers and the labor market would send out a signal (higher wages for engineers) and we would expect people to respond in a predictable fashion.  As more people decided to become engineers there would be more people needing to borrow money to finance their schooling and the capital market would send out the appropriate signal (higher price) which should result in adequate financing. The analysis of what goes on in these markets, because it is at the center of the market system, will be the discussed at the outset of the course as we examine the supply - demand model of prices.

In Macroeconomics the emphasis is on how well these aggregate markets function.  Can we expect the labor market to function effectively so that all people looking for work can find it?  Will there be a job waiting for you when you graduate? Can we expect the output market to function properly?  Will there be inflation which will erode the buying power of your earnings and will there be growth so that we can enjoy a future in which the standard of living continues to rise? And will the capital market provide enough funds so that people can borrow money to finance their education and buy their cars and homes on credit or will there be a return to 18 percent mortgage rates and credit crunches.

Before we begin our detailed discussion of either micro or macro, we will take a moment to discuss some of the alternative perspectives on economic systems.   Economists are notorious for their ability to disagree and we will briefly examine one source of disagreement - what some would call ideological perspective.