• Choices about what to do with resources are resource allocation decisions.

• Choices about who owns resources are resource ownership or property rights decisions.

• Resource allocation and resource ownership choices include decisions about what outputs a society will produce with its resources, how it will produce this output, and to whom the output will be distributed.

• The combination of the resource ownership and the resource allocation methods used in a society determines the society's type of economic system.

• Command systems use governmental regulation or central planning to allocate resources.

• Market systems use decentralized interactions between buyers and sellers to allocate resources.

• Having ownership of a resource or output means having the right to consume it, keep it, or sell it to another. At one end of the resource ownership spectrum are socialist systems, which are also known as public property or communal ownership systems.

  • In most socialist systems, resources are jointly owned by the public and are held by the government.

  • Under socialism, individuals cannot trade the right of ownership away because resources and outputs are publicly owned.

  • At the other end of the resource ownership spectrum is capitalism, which entails private property ownership.

  • In capitalist systems, individual people, households, or businesses have tradable ownership rights to resources.

• Market socialism is an economic system that uses public property ownership and private resource allocation decisions.

• Command capitalism is an economic system that uses private property ownership and public resource allocation decisions.

• Emphasizing more of one type of economic system over another involves trade-offs. The primary trade-offs that arise when we emphasize one economic system over another are between efficiency versus equity and between security versus liberty.

• Market capitalist economic systems are quite effective at generating efficient resource allocations because they tend to rely on comparative advantage. In market capitalist systems, prices provide individuals and businesses with incentives to specialize in production according to their comparative advantage and then trade with others who have comparative advantage in other goods or services.

• In market capitalist systems, the people who have the highest willingness and ability to pay for a good or service obtain the good or service from suppliers who have comparative advantage in its production and are able to produce at the lowest cost.

• Trades that generate equilibrium between buyers and sellers in market capitalist systems maximize the consumer and producer surplus derived from production and consumption.

• The invisible hand is the self-regulating mechanism of market systems that generates allocation of resources based on self-interest, competition, and comparative advantage.

  • In the book, An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith noted that market capitalist systems can produce efficient resource allocations with very minimal government involvement.

  • He called this self-regulating mechanism of allocation the invisible hand, saying

"[The individual decision maker], intends only his own gain; and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it."

• Command socialist systems are not as well suited to generate economic efficiency. In command socialist economic systems, the prices and quantities of goods and services are determined through central planning, where government serves to coordinate the production and distribution of society's resources.

  • Although it is feasible that central planning could coordinate production based on people's comparative advantage, the sheer amount of information necessary to determine who has comparative advantage in what and how resources should be allocated within the system implies that substantial social resources would need to be devoted to the information gathering, analysis, and regulation of activity in order to ensure that resources are allocated to their best use.

  • In addition, resource prices and quantities that are set by the government are less likely to provide an incentive for producers or sellers to find the lowest cost method of producing goods and services.

• Market capitalism is not equitable because market capitalism distributes goods and services based on willingness and ability to pay rather than on an equal distribution of goods and services among members of society.

  • One criticism of market capitalist systems is that they are unlikely to produce many goods and services for the poor because the poor lack the ability to pay for goods and services.

• Economic security means having a stable standard of living. Economic security can come from having a steady source of income from employment, investments, savings, a retirement fund, or some other source.

  • We trade away some of our economic liberty in order to increase our economic security through policies like mandatory unemployment insurance, mandatory Social Security taxes, worker's compensation insurance, and welfare programs that establish a minimum standard of living for people in society.

  • Because command socialist economic systems tend to be more equitable, and because obtaining that equity involves redistribution of income from some groups to others through taxes or other policies, command socialist economic systems generate more economic security than do market capitalist economic systems.

• Market failure is when the market generates an inefficient allocation of goods or services.

  • Sources of market failure include monopolies, public goods, externalities, and imperfect information

• A monopoly is a market with only one seller of a good or service.

• When it is not possible for sellers to exclude nonbuyers from using a good, the good is called a public good.

  • Public goods cause market failure because when people are able to get goods or services without paying for them (called free riding), sellers have no mechanism to recoup the costs of producing the good.

  • When sellers can't cover their costs of production, they have no incentive to provide the good in the first place.

  • Without government intervention, public goods will not be produced in a market capitalist system even though people would derive substantial marginal benefits if the public goods were produced.

• Externalities are costs or benefits of a trade that are imposed on people outside the trade.

  • When a manufacturing company dumps its waste into a nearby river, for example, it generates costs that are borne by the people downstream.

  • In a market capitalist economic system, the manufacturing company has no incentive to take these external costs into account when making its production decisions.

  • As a result, the firm's output level will not reflect the full marginal costs to society that are generated by the firm's production, and the resulting allocation of resources will be inefficient.

• Imperfect information occurs when the full costs or benefits of a trade are not known to all of the parties engaged in the trade.

  • In the market for used cars, for example, sellers know the condition of the cars they are trying to sell the cars may be defective lemons or may be in great shape.

  • Buyers do not have enough information about all prospective cars to know whether or not a given used car is a lemon, so they tend to offer relatively low prices for used cars.

  • This implies that sellers of high-quality used cars get relatively low prices for their cars because their good used cars are grouped with the lemons in buyers' minds.

  • Faced with price offers that are lower than their cars' value, sellers of good used cars have incentives not to sell their cars at all, leaving only the lemons for sale in the used car market.

  • Buyers who want high-quality used cars will understand that the used-car market consists primarily of lemons, and will thus prefer not to buy used cars.

  • Imperfect information on the part of buyers can result in limited or non-existent markets for high-quality used cars, even though mutually beneficial trades of high-quality used cars could occur.