Chapter 4-- The Mixed Economy

1. The Three Questions of Economics
1. What shall we produce?
1. In the US most of our production is geared toward consumer goods.
2. About 4% of our production is for military goods.
3. The Soviets had it in reverse-- they produced a lot of military goods, but their citizens had trouble finding enough consumer goods on the shelves.
4. Who decides?
1. In the US, its mainly consumers. You can say that our markets are demand-driven.
2. In countries like the former Soviet Union, Cuba, and China it is the government who decides what shall be produced.
1. We call this "central planning."
3. These countries are out of sync with the wants and needs of their citizens, and severe shortages of consumer goods often results.



2. How shall these goods be produced?
1. In America and most other places, nearly everything is made by private businesses (often called "the private sector")
2. In Communist countries, the Government is the main producer. Businesses are "nationalized." (owned by the government).
1. If you work in government, you work in "the public sector."



3. For whom shall these goods be produced?
1. Basically, our economic system boils down to the more money you have, the more you can buy.
1. That's pure capitalism.
2. However, we don't really operate under pure capitalism-- the Government intervenes.
1. Or interferes, depending on your point of view.
2. The Government, in theory, taxes those who have the most more than those who don't and gives that money to the poor and elderly.
3. This provision of societal needs puts a bit of Socialism into our economy.
3. The Communists have a different idea about "who gets what" than America.
1. Their credo is: from each according to his ability, to each according to his needs.
2. The Soviets perverted that idea creating a massive bureaucracy that instead of serving the public as intended, wanted to be served.
4. Old saying from page 72:

Q: What's the difference between capitalism and communism?

A: Under capitalism, man exploits man; under communism, its just the opposite.

1. The Invisible Hand, the Price Mechanism, and Perfect Competition
1. Scottish professor Adam Smith coined the term "the invisible hand" more than 200 years ago which explains that people working in their own self-interest ultimately promote the greater interests of society.
1. Example: less than a decade ago about 30% of the food produced in the Soviet Union was produced by private farmers (2% of the total!) The other 98% of the farmers worked on government owned farms.
1. The independent farmers were obviously much more productive than the government employed farmers.
2. They were way more productive because the 2% worked in their own self-interest. Adam Smith was right.
2. The Invisible Hand is the profit motive.



2. The Price Mechanism
1. The price mechanism is, simply, the laws of supply and demand.
2. Prices send signals to consumers.
1. The higher the price, the lower the quantity demanded, and visa versa.
3. Prices send signals to producers.
1. The higher the price, the higher the quantity supplied, and visa versa.
4. When consumers crave more of something, they become willing to pay more for it. This drives the price up, and producers become willing to supply more of it than before.



3. Competition
1. Competition (or lack of it) works hand-in-hand with the laws of supply and demand to determine the price levels of goods.
1. Again, if consumers demand more of something, they will be willing to pay more for it. This signals producers to produce more of it. Moreover, even more people may decide to become producers if they smell money.
2. Now we have competition.
3. What do you think competition does to prices?
4. You're right, it exerts downward pressure on prices.
2. A primary benefit of competition: goods that are plentiful and cheap, therefore a higher standard of living.



4. Degrees of Competition
1. Some industries are highly competitive.
1. Agricultural products and many retailers
2. These businesses approximate what's called perfect competition.
3. Under perfect competition, each producer is so small that they cannot control the market for their goods.
4. The effects of the laws of supply and demand are most dramatic with these near-perfectly competitive industries.
2. Some are somewhat competitive.
1. Like the Oil Industry with its big oil companies like Exxon and Mobil Oil.
2. Like the breakfast cereal companies: General Mills, Post, Kellogg's, Quaker.
3. Like the big auto companies: Ford, GM, Chrysler. (The auto industry has become much more competitive since the 1970's.
4. There are relatively few sellers, so its not all that competitive.
5. These businesses are examples of what's called an Oligopoly
1. Half way between Perfect Competition and Monopoly.
6. Each of them have some control over industry prices.
3. Others are hardly competitive at all.
1. Like Microsoft.
2. We call such firms monopolies.
3. A monopoly is an industry with one, and only one, seller.
4. This single seller controlling the supply hence also controls the price.
5. The laws of supply and demand don't have much of an effect on monopolies.



5. Equity and Efficiency
1. By "efficiency" here, we mean efficient markets. In other words, the government should sit back, not interfere, and allow the invisible hand to do the rest: consumers will demand goods and services and perfectly competitive industries, by serving their own interests, will provide them for the good of society.
1. There is another term that you may have heard to describe this: laissez faire-- which is French for "let them do!" In other words, Uncle Sam, leave us alone!
2. There is another point of view-- the case for equity-- or equality.
1. By equality here we mean equal incomes, not equal worth as human beings.
2. Should everyone make the same money? Some people think so.
3. The equity theory is that the Government should step in and take from the rich and give to the poor-- just like Robin Hood.
4. It's hard to argue against providing necessities to our least able. That's just plain old human decency.
5. But how much is too much? This is a hotly debated issue.
3. It is this balancing act that we in the United States perform with efficiency and equity (capitalism and socialism) that makes us a mixed economy.

1. The Circular Flow Model



1. The Flow Between Households, Businesses, and Governments



1. Households (individuals or groups of individuals under one roof) provide land, labor, capital, and entrepreneurial ability directly or indirectly to businesses.
1. In exchange for land, businesses pay rents.
2. In exchange for labor, businesses pay wages & salaries.
3. In exchange for capital investment, businesses pay interest and dividends.
4. In exchange for entrepreneurial ability, businesses pay profits.



2. These rents, wages & salaries, interest & dividends, and profits become the incomes of the households.



3. Households spend most of their incomes on consumer goods and services.
1. The income not spent on consumer goods is put into savings or investments.
1. These monies go right back to businesses as capital investment.



4. Businesses, in exchange for the monies received from consumers, provide goods and services.



5. Governments-- local, state, and federal-- are also a party to the flow of money, resources, and goods & services.



1. The government receives taxes from households, and in return provides services.
1. National defense, schools, roads, police, etc.



2. The government receives taxes from businesses, and in return provides services.
1. enforcement of contracts, maintains competition.



3. Like business, the government needs resources, too.
1. Governments buy land and other natural resources.
2. They employ a large percentage of the population.
3. They seek capital by issuing treasury securities.
1. treasury bonds, bills, and notes.



4. And, the government is a pretty big customer. Governments buy everything and anything you can think of-- cars, trucks, planes, computers, supplies, food, and much more.
1. Word on the street says they've even bought some $500 hammers!



5. Last, but not least, the government takes some of the $1.3 Trillion it collects from us each year and redistributes it with programs like Social Security, Medicare, Medicaid, Unemployment Compensation, and more.



6. One last party to the flow: foreign countries and their businesses.
1. Our dollars go overseas in exchange for imported goods.
2. We get dollars when foreigners buy our goods.
3. For several decades, we have been running a trade deficit.
1. imports > exports
4. Our government gives a great deal of aid to countries in need.



2. Market Failure

Market failure is the inability of the price system to solve all of society's economic problems. The Price System has some unintended side-effects, both good and bad. Furthermore, if left up to the private sector, some things that we all need and enjoy would never come about.

1. External Costs (Social Costs)
1. Our system of supply and demand produces many unintended and undesirable consequences.
1. Since capitalism is demand-driven, producers are inclined to produce luxuries for the rich rather than necessities for the poor.
1. Like all people, the poor have basic needs, too. But under pure capitalism, the poor's lack of means to pay for things results in too little quantity supplied-- a shortage in necessities.
2. When we drive, we pollute the air.
3. When our factories operate, they pollute the water, land, and air.
4. When our mining industries extract minerals, they pollute and desecrate the lands.
5. When we cut timber, we change the ecological characteristics of the land.



2. We Americans have decided that the Government should step in and "fix" these problems. That is, the Government should "interfere" with the marketplace.
1. Most economists agree that some interference is necessary. However, it is the extent of the Government's role that is in question.



3. Since Adam Smith's ideas carry some bad side-effects, what does the Government do to alleviate them?
1. Well, when industries pollute, they tax and fine them so heavily that they are forced to "clean up their act."



2. To ensure that the poor can purchase basic necessities, the Government administers various programs including food stamps, medicaid, cash assistance, low-income housing, energy assistance, etc.
1. These programs would not exist in a purely capitalist economy.



2. External Benefits (Social Benefits)
1. Our system of supply and demand produces many unintended benefits, as well.
1. So here, the government gives the invisible hand a little push.



2. Imagine that you have developed a new technology that takes old tires and shreds & processes them into useful materials for construction. Your operation turns out to be profitable. You apply for a government grant and are approved. Now you can expand your facility and process even more tires.
1. Why would the Government give you money?
1. Because, even though you are working in your own self-interest, you are doing something that is beneficial to society.
3. Government knows that a business school education is a valuable thing to society, and that's why Uncle Sam provides student loan guarantees.



4. Government programs, however, are not the best source of funding for new ideas-- private investment works best. Nevertheless, the Government lends a hand to the invisible hand!



3. Lack of Public Goods under the Price System
1. Here are some things that we all get benefit from whether we pay for them, or not:
1. Police protection, national defense, prisons, roads and highways, public schools, public hospitals, national, state, and local public parks.



2. Of course, we do pay for them through taxes we pay. But keep in mind that some pay more taxes than others, and some pay none at all.

1. What we have here is the Government stepping in and funding these social necessities, that, if left up to the private sector, would never come about, because such goods and services are not profitable.



2. We can't carve up a new Route 219 and sell it to investors-- each one owning their own stretch of highway! If it is to be built, the Government will have to fund it for the benefit of the public at large.



3. In other words, it is up to the Government to pay for the things society needs that aren't provided for in the free market.



1. Capital
1. Capital-- again, defined
1. It is one of the "factors of production."
1. Land, labor, capital, entrepreneurial ability.



2. Typically defined as "plant and equipment."



3. Most people believe money fits into the definition of capital, too.
1. It does-- IF money is used for productive purposes, NOT consumption.
2. You see, it TAKES money to buy plant and equipment!



4. "Capital is past savings accumulated for future production." (p. 69)



5. Karl Marx, 19^th Century German economist, historian, and philosopher, known as the Father of Communism: Whoever controls a society's capital, controls that society.
1. Is that true? Well, if you owned a substantial amount of stock in a company, you would undoubtedly have significant control over that company's activities!
2. Marx believed that eventually workers would revolt against the tyranny of their employers and seize control of the means of production; and then, a utopian society would be born, and these words would be its creed:
1. from each according to his ability, to each according to his need.
3. Under Communism, as we have come to know it (Marx must have rolled over in his grave), the workers do own the means of production, BUT the control of those resources has been in the hands of party leaders. So much for Utopia.



2. Capital is created when people save a portion of their incomes. Once invested, these savings provide business with the investment necessary to expand operations, develop new technologies, and develop new products.



3. Capital is the key to every society's standard of living.



4. One important difference between India and the United States has been capital. Availability of capital explains the difference in Indian and American standards of living.
1. India certainly has no shortage of land or labor (or even entrepreneurs)!





2. Specialization and Its Consequences
1. Specialization-- defined
1. Each of us has a "specialty," or something we do well-- perhaps even better than most others.
1. Personally, I have no construction skills, but I have friends and acquaintances that do.
2. If I need something built, I have two choices:
1. Call someone who specializes in this kind of thing.
2. spend countless hours (and dollars) trying to figure out which end of the nail to hit, resulting in much swearing before I finally give up and call someone who knows.
3. I would best allocate my resources (skills, time, and money) in such a way I could do the most good for my family, others, and myself, right?



2. Specialization is one of the key factors of our existence as a civilization.
1. If you specialized in growing corn, you could produce more than enough to feed your family and trade your surplus with others who specialized in some other commodity.
2. Specialization enabled trade.
3. Trade brought about communities.
4. Think about it, self-sufficient people can isolate themselves, but people, people who need people, are the luckiest people in the world. (Barbra Streisand)



3. A cousin to specialization is the concept of division of labor.
1. Consider the manufacture of an automobile:
1. You have people who do one and only one thing all day long-- like bolt on a door.
2. After several thousand of these doors, I'll bet he or she is pretty darn good and pretty fast at performing this task, wouldn't you?
3. Each assembly worker becomes an expert or a specialist at their job.
4. One result of specialization, then, is efficiency.
1. And, after all, isn't that what economics is all about-- efficient allocation of resources. . . ?



5. Not so fast, 10W-30 breath! Don't get too excited about efficiency. People aren't machines, you know! There is a downside.
1. Boredom! Apathy! Alienation! Take your pick.



6. Enlightened managers have learned to sacrifice a little of the specialization and efficiency for the sake of workforce morale and "organizational climate."
1. Saturn employees rotate jobs giving them a greater scope of duties. They get to see the finished product.



3. Capitalism, Communism, Fascism, and Socialism-- The Four Great Economic Systems
1. Capitalism
1. Private ownership of the means of production-- land, labor, capital, entrepreneurial ability.
2. Production is moved by the profit motive (the invisible hand).
3. Economy is demand-driven (consumer sovereignty)
4. Government's role is minimal-- make sure we play by the rules.



2. Communism
1. Abolition of private property.
2. State owns everything.
3. Government decides what will be produced and who will get what.



3. Fascism
1. Best example: Hitler's Nazi Germany.
2. Private ownership with Government dictating what was to be produced.
3. High priority on military goods, less on consumer goods.
4. No economic freedom. Government has total control.
5. Fascist states have always been economic failures.



4. Socialism
1. Often confused with Communism.
1. Difference:
1. communism: state owns all key industries
2. socialism: state owns some of the key industries.



2. Many of our allies have socialist economies.
1. Canada, Great Britain, France, Sweden, and Greece.



3. "Cradle-to-Grave" Security
1. Education, medical care, retirement benefits, and other essential needs are FREE and guaranteed to each and all citizens!
2. There is a price tag, however (Don't you know that in economics there is no free lunch?).
1. VERY HIGH TAXES!



3. Norway
1. free day care, subsidized housing for all, vacations, free medical, a check from the government for $1600 every child under 17 you have, 42 weeks paid maternity leave, and retirement pay for homemakers.
2. They pay for this with the WORLD'S HIGHEST INCOME TAXES, 23% SALES TAX, AND GASOLINE TAX OF $5 PER GALLON!!!



4. Sweden
1. Slightly less socialist tone to the economy, yet many of the above securities.
2. They also have high taxes, but have one of the world's highest standards of living!



5. Summary with the "cow" analogy on page 75

Socialism: You have two cows. State takes one and gives it to someone else.

Communism: You have two cows. State takes both and gives you milk.

Fascism: You have two cows. State takes both and sells you milk.

Capitalism: You have two cows. You sell one and buy a bull.