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*ANSWERING THE THREE ECONOMIC QUESTIONS*

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*SECTION 1*

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1) What goods and services should be produced? 2) How should these goods and services be produced? 3) Who consumes these goods and services

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-Resources are scarce everywhere. As a result, every society must answer three key economic questions:

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economic system

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The way a society answers these three questions defines its

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the structure of methods and principles that a society uses to produce and distribute goods and services

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Economic System

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1) Each society must decide what to produce in order to satisfy the needs and wants of its people. -While all people need food and shelter, societies face additional important considerations. 2)How much of our resources should we devote to national defense, education, or consumer goods? 3) Because resources are limited, each decision that a society makes about what to produce comes at an opportunity cost.

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What Goods and Services Should Be Produced?

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1) A society must also decide how to produce goods and services -What fuel should we use to generate electricity--oil, solar power, or nuclear power? -Is education best delivered through public or private schools? 2) Although there are many ways to produce goods and services, all require land, labor, and capital. 3) These factors of production can be combined in different ways. 4) These decisions involve trade-offs.

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How Should Goods and Services Be Produced?

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1) Societies also make decisions that determine how goods and services are consumed. - How can people meet their needs for food and medical care? -Who gets to drive a new luxury car and who can only afford bus fare? -Who gets access to a college education? 2) The answer to such questions is largely determined by how societies distribute income. 3) Factor Payments 4) Landowners collect rent, workers earn wages, and those who lend money receive payments called interest. 5) Factor payments also include the profits that entrepreneurs earn if their enterprises succeed. -How much should we pay the owners of the factors of production? -How do we decide how much teachers should earn versus how much doctors should earn? 6) The answers to such questions tell us a great deal a society's values.

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Who Consumes Goods and Services?

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the income people receive in return for supplying factors of production

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Factor Payments

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the amount of money a business receives in excess of its expenses

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Profit

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economic goals

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Different societies answer the three economic questions based on the importance they attach to various

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efficiency, freedom, security, equity, and growth.

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These goals include:

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produce using the resources they have.

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Because resources are always scarce, societies try to maximize what they can

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economic efficency

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If a society can accurately assess what its people need and want, it increases its

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second and third questions.

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The goal of reducing waste also involves the

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consumers

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Producers seek better ways to create goods and to make them available to

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efficient

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An economy that cannot deliver the right goods in the right quantity to the right people at the right price is not

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choices

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Most people value the opportunity to make their own

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economic freedom

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Still, people all over the world face limitations on their

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individual freedom

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Key cultural value for Americans

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freedom

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We prize the _____ to buy what we can pay for, to seek work where we want, to own property, and to become entrepreneurs.

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economic systems

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Ideally, ________ seek to reassure people that goods and services will be available when needed and that they can count on receiving expected payments on time.

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security

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We also want the _____ of knowing that help is available if we are in need.

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a set of government programs that protect people who face unfavorable economic conditions

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Safety Net

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Most modern nations also provide some level of base income for retired persons to ensure that they can support themselves.

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Example of Safety net

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Equity

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_______, or fairness, is another economic goal that is defined differently in different societies.

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economic pie

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Each society must decide how to divide its

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-Should everyone get the same share of the goods and services a nation produces? -Or should one's consumption depend on how much one produces? -How much should society provide for those who are unable or unwilling to produce?

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Example of Economic Equity

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new people joining the workforce

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A nation's economy must grow with its population so it can provide jobs for the

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income

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A nation's economy must grow if people are going to have more

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standard of living

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When that occurs, the nation improves its

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level of economic policy

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Standard of Living

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economic growth

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Innovation plays a huge role in

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the process of bringing new methods, products, or ideas into use

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Innovation

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- During the Industrial Revolution of the 1700s and 1800s, innovations in technology increased the efficiency of production and introduced new goods and services. - Many problems arose, such as harsh conditions in factories and crowded cities, as well as increased pollution of air and water. - Yet, the Industrial Revolution also sparked economic growth and led to an overall rise in standards of living.

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Example of Innovation (Economic Growth)

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work, do business, find information, and communicate

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Today, innovations in computer and networking technology are changing how people

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goals

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A society may value other ______ than these.

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1) Environmental protection 2) Full Employment 3) Protecting National Industries

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Other Economic goals

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conflict

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Sometimes, economic goals _____ with one another.

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- When a society provides a safety net for all citizens, the added cost may slow economic growth. - To protect the environment, a government may impose regulations on manufactures which curb economic freedom.

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Example of economic goal conflict

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Each choice comes with some kind of trade-off.

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All nations must prioritize their economic goals, or arrange them in order of importance.

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four different

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Societies have developed ___ ____ economic systems to address the three key economic questions.

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prioritization

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Each system reflects a different ______ of economic goals.

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Economic system

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It also reflects the values of the societies in which these systems are found.

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traditional economy

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The oldest and simplest of economic systems is the

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an economic system that relies on habit, custom, or ritual to decide the three key economic questions

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Tradition Economy

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innovation or change

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There is little room for

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often an extended family made up of several generations.

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The traditional economics system revolves around the family unit--

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gender lines.

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Work tends to be divided along

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Traditional Economy

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are usually found in communities that tend to stay relatively small and close.

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rather than just themselves or their immediate families.

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Often people in these societies work to support the entire community,

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Traditional economy

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Societies with _____ ____ are economically successful if they meet their own needs.

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may not have access to a wide range of goods.

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Societies with traditional economies

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these communities lack modern conveniences and have a relatively low standard of living.

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In most cases,

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*THE FREE MARKET*

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*SECTION 2*

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chief characteristic of a free market economy

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Economic freedom

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-farmer's market -sporting goods store -NY stock exchange -community bulletin board advertising a baby sitter position

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Examples of markets

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any arrangement that allows buyers and sellers to exchange things

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Market

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eliminate the need for any one person to be self-sufficient.

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Markets

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needs and wants

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None of us produces all we require to satisfy our

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us to exchange the things we have for the things we want

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Markets allow

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specializes

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Instead of being self-sufficient, each of us ____ in a few products or services

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the concentration of the productive efforts of individuals and businesses on a limited number of activities

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Specialization

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-A baker specializes in making breads, cakes, and cookies -A nurse specializes in caring for the sick -An aircraft plant manufactures planes, not refrigerators

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Example of specialization

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efficient use of capital, land, and labor

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Specialization leads to

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to learn them all.

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It is easier for people to learn one task or a few tasks very well than

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they can do their work more efficiently, saving resources by avoiding waste

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because they concentrate on one or a few tasks,

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the top performers in most fields are specialists who have worked hard to sharpen their particular skills

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For this reason,

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focus on a limited number of related products or services and to use them more efficiently

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Specialization also benefits businesses because it allows them to

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people typically earn income by specializing in particular jobs. They use this income to buy the products that they want to consume.

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Modern market-based economy

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an economic system in which decisions on the three key economic questions are based on voluntary exchange in markets.

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Free market economy

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what gets made, how it is made, and how much people can consume of the goods and services produced.

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The choices made by individuals determine

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buy or sell

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Individuals and businesses make their own decisions about what to

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capitalist economies

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Market economies are also called ____ _____ because the capital that entrepreneurs invest in businesses is a vital part of the system.

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individuals and privately owned businesses own the factors of production, make what they want, and buy what they want

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In a free market system,

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households and individuals

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The participants in a free market economy are

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a person or group of people living in a single residence

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Household

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factors of production (land, labor, and capital)

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Households own the

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Household

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Consumers of goods and services

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an organization that uses resources to produce a product or service, which it then sells

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Firm

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the FOP into goods and services

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Firms make

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1) Households supply firms with land, labor, and capital 2) Firms supply households with goods and services

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Physical Flow

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1) Households pay firms for goods and services 2) Firms pay households for land, labor, and capital

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Monetary Flow

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the arena of exchange in which firms purchase the factors of production from households

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Factor Market

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hire workers, paying them wages or salaries for their labor. They also borrow money from households to purchase capital, paying households interest or profits in return.

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Firms purchase or rent land and they

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the arena of exchange in which households purchase goods and services from firms

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Product Market

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self- interest

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The free market system is based on

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affordable goods and services

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Buyers want

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profits

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Entrepreneurs want

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good pay

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Employees want

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labor

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Employers want

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people to behave in their own self- interest

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Incentives influence

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an individual's own personal gain

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Self- Interest

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have the incentive to look for lower prices

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Consumers, pursuing their self- interest,

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the hope of reward or fear of penalty that encourages a person to behave in a certain way

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Incentive

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monetary, or based on money, such as the promise of higher wages or profits

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Many incentives are

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prestige and personal satisfaction one gets from running a successful business

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Non-monetary

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lower prices by buying more goods, because spending less money on a good lowers the opportunity cost of the purchase

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Consumers will respond to the positive incentive of

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higher profits by increasing sales

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Firms seek to make

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the struggle among producers for the dollars of consumers

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Competition

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competition is the regulating force

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Which self- interest is the motivating force behind the free market,

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regulate the marketplace

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Self- interest and competition work together to

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consumers purchase certain goods and services and firms to produce them

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Self- interest spure

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firms to produce more and moderate their desire to raise prices

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Competition causes

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that operates efficiently

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No consumer or producer has made decisions based on what's good for the market place, yet the end result is a marketplace

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a term coined by Adam Smith to describe the self- regulating nature of the marketplace

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Invisible Hand

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these goals on its own

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Under ideal conditions, the free market meets many of

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-Because it is self- regulating, a free market economy responds efficiently to rapidly changing conditions - Producers provide only the goods and services that consumers want, and generally at prices consumers are willing to pay

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1) Economic Efficiency

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- Free market economic have the highest degree of economic freedom of any system. -Workers work what they want, firms produce what they want, and individuals consume what they want.

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2) Economic Freedom

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- Because competition encourages innovation, free markets encourage growth. - Entrepreneurs are always seeking profitable opportunities, contributing new ideas and innovations

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3) Economic Growth

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- Free markets offer a wider variety of goods and services than any other system, because producers have incentives to meet consumers' desires. - Consumers, in essence, have the power to decide what gets produced (consumer sovereignty)

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4) Additional Goals

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the power of consumers to decide what gets produced

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Consumer sovereignty

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no country today operates under a pure, unregulated free market system.

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Despite the advantages of a free market economy,

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free market

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The same features that make free markets attractive also represent the weaknesses of the

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an economic system in which the government makes all decisions on the three key economic questions

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Centrally Planned economy

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central bureaucracy

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A ______ ________ decides what items to produce, how to produce them, and who gets them.

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government

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Owns both the land and capital and also labor. They control where people work and what they are paid. The _____ directs workers to produce a certain number of trucks, so many yards of cotton fabric, and so one. Farmers are told what to plant and where to send their crops.

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another name for centrally planned economy

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Command economies

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-private property -free market pricing -competition -consumer choice

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Command economies oppose

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command economies

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Free market forces of self- interest and competition are absent in

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1) The top planners decide that more military uniforms than sweaters will be made. They send this decision to the materials committee 2) Knowing how much cotton is available, the materials committee decides how many uniforms and sweaters to produce. They send their decision to the makers of cotton, buttons, and elastic 3) The cotton, the buttons, and the elastic arrive at factories, where they are used to make uniforms and sweaters.

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Example of how a central planning economy works

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centrally planned economies

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No consumer sovereignty

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a range of economic and political systems based on the belief that wealth should be distributed evenly throughout a society

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Socialism

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a single economic system

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Socialism is not

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Economic equity

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______ _______, socialists argue, can exist only if the centers of economic power are controlled by the government or by the public as a whole, rather than by individuals or corporations.

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has socialism coexisting with free market practices

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Sweden

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the government uses its powers of taxation to redistribute wealth and provide extensive services

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Market socialism

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government ownership of the means of production

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Other socialists stress

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capitalism and communism

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They consider socialism to an intermediate stage between

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the central government owns and controls all resources and means of production and makes all the economic decisions

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Communism

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communist governments have always been authoritarian.

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While countries with socialist economies can be democratic,

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describes a form of government that limits individual freedoms and requires strict obedience from its citizens

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Authoritarian

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Karl Marx and Joseph Stalin

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Communism (review pages 36-37 about the big leaders)

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1) *Efficiency*- In a centrally planned economy, the government owns all the factors of production. Since the government fixes wages, workers lack the incentive to work faster or produce more. The large, complex bureaucracy needed to make thousand of economic decisions hurts efficiency as well. It is expensive to run and lacks the flexibility to adjust quickly to consumer demands and changing economic conditions. 2) *Freedom*- Traditionally, command economies sacrifice individual freedoms in order to pursue societal goals. Sometimes, the results have been brutal. Central planning discourages competition and takes most of or all economic choices away from producers and consumers. 3) *Growth*- innovation is key to economic growth. Command economies, however, do not tend to reward innovation--in fact, they discourage change. Managers must follow an approved government plan. There is no profit incentive to encourage entrepreneurship. 4) *Equity*- In theory, a major goal of communism is to increase equity by distributing goods and services fairly. Such equity has proven rare, though. Government officials and people in favored careers enjoy higher incomes and access to a wider variety of higher quality goods. Ordinary people often suffer shortages and poorly made goods. 5) *Additional goals*- It can also be used to jump start selected industries.

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Disadvantages of Centrally Planned Economies

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*MIXED ECONOMIES*

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*SECTION 4*

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has little potential for growth or change

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Traditional economies

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stifle innovation, do not adequately meet consumer needs, and limit freedom

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Centrally planned economies

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the doctrine that government generally should not intervene in the marketplace

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Laissez Faire

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1) Some needs of modern society would be difficult to meet in the marketplace. 2) Governments supply some needs in order to ensure that all members of society can benefit. 3) Protecting property rights 4) Make exchanges in the market place fair

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Reasons for government intervention

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property that is owned by individuals or companies,not by the government or the people as a whole

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Private property

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a market based economic system in which the government is involved to some extent

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Mixed economy

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land, labor, capital **Same is true for the government

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Firms purchase _____ _____ and ______ from households in the factor market

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goods and services

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Like households, governments purchase _______ and _____ from firms in the product market.

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combining the fact resources they bought.

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Government also provide certain goods and services by

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households and businesses

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Government collects taxes from both

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a period of change in which a nation moves from one economic system to another

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Economic transition

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the process of selling businesses or services operated by the government to individual investors, and then allowing them to compete in the marketplace

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Privatization

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free market

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Which the American economy is a mixed system, the foundation of the US economy is the

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an economic system characterized by private or corporate ownership of capital goods

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Free Enterprise system

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order, provides vital services, and promotes the general welfare.

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The American government keeps

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protect private property

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Federal and state laws

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government regulation

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The marketplace operates with a limited degree of

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1) Foreign investment is encouraged 2) Free trade is too 3)Government does protect some domestic industries and does retaliate against trade restrictions imposed by other nations

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Economic Freedom in the US

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