The Fundamentals of Economics

• What goods and services should be produced?
• How should these goods and services be produced?
• Who consumes these goods and services?

The economic system that a society uses is determined by the way it answers these three questions. Therefore, an economic system is the method a society uses to produce and distribute goods and services.

There are two major types of economic systems:

• Centrally planned (command economy): China has a primarily centrally planned economy.
• Free market (capitalist economy): The United States has a primarily free market economy.

The government owns all the resources in a centrally planned economy. The government tells workers where they should work and what jobs they should perform. The government decides what to produce, how to produce it, and for whom to produce it.

Individuals decide what to produce and how to produce it in a free market economy. The market (consumers) dictates what products are available. If consumers don’t buy a product, there is no market for it, and no company will make it.

The invisible hand, the most important concept of capitalism, recognizes that a society will meet its goals as individuals take self-interested actions. In other words, there are social benefits when individuals in a society better themselves.

Competition and self-interest act as an invisible hand that regulates the free market. For example, if consumers want gas-efficient cars:

• companies produce more gas-efficient cars;
• competition among companies results in high quality, greater efficiency, and low prices; and
• the needs of society are met.

Almost all countries, including the United States, have mixed economies. Each country has a free market and some government involvement. The amount and type of involvement varies from country to country.

Markets are usually the best way to organize economic activity. In a market economy, resources are allocated through the decentralized decisions of many companies and individuals as they interact in markets for goods and services.

Market economies are more effective than centralized economies. Market price usually reflects the value to consumers and the cost to producers. Centrally planned economies fail because they do not allow the market to function. In centrally planned economies, individuals and businesses have little incentive to succeed.