So what is economics? Economics is the study of how individuals and businesses make decisions to best satisfy wants, needs, and desires with limited resources. It is about businesses making goods (such as books, pizza, or computers) or supplying services (such as giving haircuts, painting houses, or installing home entertainment centers) that we want or need to buy.

Because businesses don’t have enough tools, money, or products to provide all the books, pizza, or haircuts that we want, they must decide what and how much to make. Likewise, not everyone will be able to have what he or she wants because people’s resources are limited. Therefore, economists look at how resources are distributed in the marketplace and how equitably and efficiently those resources are disbursed. There are two basic studies of economics: microeconomics and macroeconomics.

What are the types of economic systems? An economy is a system that tries to balance the available resources of a country, such as land, capital, and labor, against the wants and needs of consumers. An economy is defined by (1) what is produced, (2) how it is produced, and (3) who gets the finished product. The world’s various economies can be classified into three basic economic systems:

• Planned (or controlled) economies

• Free market economies

• Mixed economies

Table 2.1 explains the differences between these basic types of economic systems. Planned and free market economies lie at opposite ends of the spectrum in terms of government control. Each national economy has some element of planned and free economic systems. The main difference between each economy, and between planned and market economies in general, is the degree of individual autonomy.

Table 2.1

Types of Economic Systems around the World

In a planned economic system, the government plays a significant role in determining the goods and services produced and distributed. Communism and socialism are examples of planned economic systems.

Communism is an economic system in which a state’s government makes all economic decisions and controls all the social services as well as many of the major resources required for the production of goods and services. Karl Marx, the originator of communist principles, envisioned in his landmark book The Communist Manifesto that workers themselves would eventually take over the government’s responsibilities to provide services. No country operating in a communist system has achieved this level of Marx’s vision. Existing communist states, including North Korea and Cuba, are failing economically. This is a result of problems that have arisen with communist systems, such as shortages of goods and services. In fact, in the later years of the twentieth century, most former Soviet republic states and Eastern European countries turned from communism-based economies to market economies to combat these problems.

Socialism is a system whereby the government owns or controls many basic businesses and services and the profits from them are distributed evenly among the people. In socialist economic systems, governments traditionally run some of the social services, such as education, health care, retirement, and unemployment, as well as other necessary businesses, such as utility companies (telephone, electric, water, and sewer companies). The government charges high tax rates to pay for the services it provides. For example, the economies of the Scandinavian ­countries of Norway, Sweden, Finland, and Denmark are more characterized by socialism than the United States is. Scandinavian countries have some of the highest tax rates in the world, with tax revenues representing between 52 and 57  ­percent of their economy. By contrast, tax revenues represent less than 20 ­percent of the United States’ economy.1

Although Scandinavians pay more taxes, they benefit from social programs that the taxes fund. For example, education at even the best universities in Denmark is free. Although paying high taxes may seem unappealing, recent studies have indicated that Scandinavians rank among the most satisfied people in the world.2

Although government-controlled and supplied social services likes those ­associated with communism and socialism can lead to resources being equitably distributed among a nation’s citizens, these economic systems have a downside: They tend to reduce people’s motivation to work as hard as they might otherwise. Why work harder when you will receive as many goods and services as your neighbor who doesn’t? Or why work a lot of overtime if you have to give half of your overtime pay to the government in the form of taxes? Therefore, it is difficult to find purely socialist economies. For this reason, many formerly socialist and communist countries have changed their economies into free market economies through the practice of privatization—the conversion of government-owned production and services to privately owned, profit-seeking enterprises.

In a market economy such as we have in the United States, individuals are able to make many of their own economic decisions. For example, there may be several pizza parlors in your town, and each one may sell slices of pizza at different prices. No one is restricting the number of pizza parlors, and no one is controlling what prices they can charge. Similarly, you are free to buy any pizza you’d like. This freedom of choice for both the buyer and the seller defines a free market economy.

Capitalism is an economic system that allows freedom of choice and encourages private ownership of the resources required to make and provide the goods and the services we enjoy. Capitalism has become a major influence in the Western world’s economic systems. In a capitalist economy, the production and pricing of goods and services is determined through the operation of a market—the mechanism by which buyers and sellers exchange goods and services.

Most economic systems are mixed economies—a blend of market and planned economies. One way to think about the various economies and how they relate to each other is to place them on a continuum, as shown in Figure 2.1.

Figure 2.1

Continuum of Economic Systems: Degree of Government Control

Most Western European countries, for example, operate with a mixed economy of privately owned businesses and government control of selected social programs, such as health care. The United States has been more of a capitalist economy than its European counterparts, but with the passage of the Affordable Care Act, a U.S. health care law passed in early 2010, the United States economic system has shifted.

Why do business managers need to be concerned with economics? Business managers and owners need to understand the principles of economics because the nature of business is to provide items or services for purchase in exchange for something, generally money. Businesses need to know how much of their goods to produce or services to offer as well as how much to charge for these products. Additionally, business managers need to be aware of the potential impact that government decisions (such as changing interest rates) and the decisions of collective businesses (such as the general level of unemployment) can have on their individual business or industry. We will discuss how economics impacts business throughout this chapter.