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Economics: Policies to Change to Market Systems


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About this Lesson

  • Type: Video Tutorial
  • Length: 11:19
  • Media: Video/mp4
  • Use: Watch Online & Download
  • Access Period: Unrestricted
  • Download: MP4 (iPod compatible)
  • Size: 121 MB
  • Posted: 03/29/2010

This lesson is part of the following series:

Economics: Full Course (269 lessons, $198.00)
Economics: International Focus (25 lessons, $43.56)
Economics: Transition Economies (4 lessons, $7.92)

This video lesson on economics looks at policies to change to other market systems. Taught by Professor Tomlinson, this lesson was selected from a broader, comprehensive course, Economics. This course and others are available from Thinkwell, Inc. The full course can be found at The full course covers economic thinking, markets, consumer choice, household behavior, production, costs, perfect competition, market models, resource markets, market failures, market outcomes, macroeconomics, macroeconomic measurements, economic fluctuations, unemployment, inflation, the aggregate expenditures model, banking, spending, saving, investing, aggregate demand and aggregate supply model, monetary policy, fiscal policy, productivity and growth, and international examples.

Steven Tomlinson teaches economics at the Acton School of Business in Austin, Texas. He graduated with highest honors from the University of Oklahoma and earned a Ph.D. in economics at Stanford University. Prof. Tomlinson's academic awards include the prestigious Texas Excellence Teaching Award given by the University of Texas Alumni Association and being named "Outstanding Core Faculty in the MBA Program" several times. He has developed several instructional guides and computerized educational programs for economics.

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Around 1990 the countries of the former communist block began a period of transition from centrally planned economy to market based economies. Now, ten years later, these economies many of them are still in transition and you wonder what is taking them so long? Isn't the market-based system simply much better than a communist system? Doesn't central planning lead to all kinds of inefficiency and trouble. So, why wouldn't a country that had central planning simply throw over their centrally planned economy and move directly to a market based system with all of its advantages? The answer is that is takes a lot of time and effort to get from the system that is driven by a central planner to one in which the centralized choice creates all of the benefits of a free market. The period of transition can take time because it is difficult. And, there are certain things that have to be accomplished along the way.
So, let's consider now the steps in transition from central planning to a free market. Remind yourself what a centrally planned economy looks like. There is a director over the economy who conducts the planning. And, the planning is designed to get individuals in the economy to use their labor, their capital, their entrepreneurial skills, and their raw materials so as to produce that basket of goods and services that could be distributed among the people in the economy and lead to the greatest level of satisfaction. This planning is usually communicated to individuals through a set of prices that are announced to the economy that are supposed to coordinate and motivate people to produce the things that the economy wants. So, by announcing the price of shoes, the price of televisions, the price of fruits and vegetables the government directs people's labor to one industry or another as there is need for this particular product.
Typically, what happens in the centrally planned economy is that capital is nationalized. That is, it is owned by the collective or by the government. So, that the profits from factories that are owned by the state and from the use of tools all goes to the government. And, can be used then to pay for public goods, like national defense and roads, and bridges, and schools and so forth. So, a centrally planned economy is one that is characterized by prices that are announced to coordinate and motivate and nationalized capital so that the profits become the property of the government and can be used to buy things for people in the economy.
Another thing that happens in centrally planned economies is that typically the money supply is under the direct control of the government. That is, if the government needs to run a deficit it can print money to pay for the excess of its expenditures over its revenue. So, the government can use the money supply as a tool of finance if it needs to run a deficit.
Now, let's begin to move from a system characterized by planning to one that is characterized by free market interaction of buyers and sellers. How do we get to a free market? Well, let's suppose that there is a peaceful revolution in this country and the individuals decide that they want to move to a system characterized by competition. They want the freedom as individuals to decide how to use their labor and tools.
How are we going to get there? Well, the first thing that has to happen is now that the planner is gone we need a new way of coordinating and motivating the individuals in this economy. What is going to get them out of bed in the morning, working, using their skills to create things that other people value? What is going to get them making that pie that creates value in this economy?
The answer is we are going to give them a stake in the economy by privatizing capital. That is, rather than the collective owning the capital now individuals are going to own capital. She is going to own her tools, he's going to own his tools and we all are going to own shares in these factories so that when they make profits we get return. Meanwhile, since I now own my own tools, and my own skills, and my own labor and I could invest them as I want, I'm going to do so in a way that maximizes a profit on those skills. That is, I'm going to look for the employment of my time and talent that gives me the biggest paycheck the biggest return that I can get. So, the interaction of supply and demand, n a depersonalized way is going to guide people to use their talent in ways that create things that other people value. So, the planner is being replaced in his role as coordinator and motivator by prices that are going to be determined by the interaction of supply and demand.
Now, that's the next thing that we have to be concerned about. After the privatization of capital provides people with motivation the next thing we are concerned about is who is going to be announcing the prices. So, the second concern is deregulation of prices. Prices used to be announced by the central planner. Now they are going to be determined by the interaction of supply and demand in a decentralized way. If there aren't enough fruits and vegetables being produced the price is going to go up because we have excess demand. That is going to leave more people in the economy to decide to start raising fruits and vegetables and that is going to push the price back down. But, in the meantime, the higher price determined by the shortage will start guiding people into that industry rather than a planner calling you up and saying why don't you become a farmer. The high price of fruits and vegetables draws you into agriculture. So, the deregulation of prices then allows supply and demand to start guiding people in the use of their talents and their resources. So, now we have factories that are privatized so that individuals have a stake in the economy. We have prices that represent the inner play of supply and demand. That is a way of collating information about what people wand and what their skills are and through prices that can direct people.
The third thing is the money supply. The government now is in a particularly tough situation because they used to make a lot of money off of these factories and they don't own them any more. So, how are they going to pay for the army, and roads, and bridges, and education and stuff like that, which the government provides? The answer is at first they are going to start cranking up the money presses, printing a lot of paper money. And, that is going to create all kinds of havoc in this economy. Because with the money supply expanding rapidly to take the place of the government previous sources of revenue we are at risk for inflation. Remember, too much money chasing too few goods and prices can go haywire. Well, that's bad for the economy because if prices start going haywire these individuals down here don't know where the best use of their time and talent is. They can'' rely on prices to coordinate and motivate their use of their resources. So, what happens in this case then is the government has to get its monetary policy under control. Typically, what a government can do is it can create an independent monetary authority like the Federal Reserve Bank in the United States. And say, look, your job is to control the money supply so that price's remain stable and reliable sources of information. So, once that happens, then the government can no longer use the money supply as a way of financing its deficits. Then it has to start issuing bonds, kind of like in the United States we issue Treasury Bonds to pay for the national deficit and the debt.
Well, this opens a whole new can of worms, because maybe there isn't even a system of financial institutions in this country. Maybe people aren't used to buying and selling bonds and stock and things like that. They may have no habit for this kind of activity. There may not be well-established banks, and trading houses, and investment bankers and all those things we take for granted in the United States. So, now they have to come up with a set of financial institutions and financial markets that will support this kind of activity, because if the government is going to be able to run a deficit, they have to have someone to sell their bonds to. That means people have to have intermediaries in which to buy bonds, or banks in which to deposit their money so that the banks can go and buy the bonds. That is, people need a set of institutions that support savings, borrowing, and the sharing of risk. So, there you have it. It's a problem.
How do we get from a system in which a central planner directs the allocation of resources in the economy to one in which the market, through competition, and the individual profit maximizing behavior of all of these people, creates the big pie that we associate with free market. How do we get there? Well, there are four sets of problems that have to be resolved. Problem number one is property right's. That is how do people get used to owning property? These people before didn't have property. The factories were owned by the government. The land was owned by the government. The tools were owned by the collective. So, now what we have to do is create a system in which individuals can own their own house, their own land, shares in factories, their own tools so that they may have a stake in using these resources to maximize profit and value. So, we need a system of contracts, and lawyers, and enforcement and all these things, once again, that we take for granted in capitalist economies. There needs to be a set of institutions that teaches people about their property rights, that enforces their property rights and allows them then to trade property, to buy and sell it in a way that has low transaction cost.
Second set of concerns is the lack of mature banking and financial system. We need a system of banks. We need a system of financial institutions. We need people to be able to buy and sell bonds and shares of stock. That is, if you are going to own capital you have got to understand how the institution works through which you do that. I need to be able to buy stock or invest through a mutual fund or things like that. So, the institutions have to arise that facilitate borrowing and lending and the sharing of risk. And, lower the transaction cost of doing that. Now, people have to learn how to interact with such a system.
The third set of problems is the problem of no standard accounting system. These people have been relying before on information from the government about how hard to work and where to use their resources. And, that's where they got their paycheck. Now, they are all interacting with each other, doing deals with each other. Which means they need a common language for doing these deals. And, that is what the accounting system is about, how we are going to communicate charges to one another, what kind of monetary units we're going to use, how we do contracts and how we convey the information that is associated with business.
The fourth set of problems is insurance. That is, I don't want to bear all the risk of running in business myself. I want to be able to sell some of the shares to someone else and to ensure myself against catastrophe. Once the insurance institutions arise then the individuals are much more likely to enter into businesses. Much more likely to employ their labor in capital and go all out and try to create value.
So, as an economy makes transition from central planning to competition all of these things have to happen. The privatization of capital, prices being deregulated and determined by markets, the money supply, now not so much a matter of government finance as a matter of maintaining price stability, perhaps being run by an independent monetary authority, and all of the players in the economy have to get used to interacting in this new way. And that means institutions arising to support this kind of interaction, whether it is the institutions associated with property rights, the institutions associated with finance, or the institutions associated with risk sharing.
So, there you have it. Property rights and these institutions are big change in the lives of people who have previously relied on central government planning. So, the transition period is not quite so simple, because it means that everyone is having to change the way they think about business and the way they interact with one another.
International Focus
Transition Economies
Policies to Change to Market Systems Page [3 of 3]

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