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 Capitalism vs. Socialism
• Capitalism
– Economic system wherein economic
decisions are made by private sector via
marketplace and means of production are
owned by private sector

• Socialism
– Economic system wherein economic
decisions are made by public (government)
sector and means of production are owned by
public sector
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 Major Regions of the World
• Western industrialized world
– Industrialized capitalist countries of the world
• EXAMPLES: United States, China, most of Western Europe

• Formerly socialist industrialized world

– Industrialized ex-socialist countries of Eastern Europe
• EXAMPLES: Former Soviet Union and much of rest of
Eastern and Central Europe

• Less-developed world
– Less-developed countries of the world
• EXAMPLES: Africa, Asia, and Latin America

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 The Western Industrialized World:
Economic Growth

• Many larger democracies of Western

industrialized world have taken on
conservative philosophy that has resulted
in restricted government involvement in
their economies and more focus on free
markets
– Domestic social programs have declined;
economic growth driving these countries in
new century

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Economic Growth Rates

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Effects of Supply-Side Policy on the Macroeconomy

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Production Possibilities with Economic Growth

• Production possibilities curve shows alternative

combinations of maximum amounts of output
that economy can produce if all of its resources
and technology are fully and efficiently utilized
– Economy can achieve higher levels of production if
production possibilities curve shifts outward over time
• Factors that cause outward shift in production possibilities
include increase in quantity or quality of society’s resources
or improvement in technology
– Factors can generate sustained expansion of output—that is,
economic growth

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 Policies to Achieve Economic Growth

• Four factors contributing to economic

growth:
– Increase in capital
– Improvement in technology
– Improvement in labor productivity
– Decrease in unnecessary regulation

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 An Increase in Capital
• Economic growth can occur if there is
sustained increase in quantity of physical
capital: that is, increase in nation’s stock of
factories, equipment, machinery, etc.
– Increase in capital made possible by increase
in investment; investment made possible by
saving—either private saving by households
and businesses or public saving through
government taxes

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 Savings Rate
• Total savings divided by gross domestic product

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 Increasing the Savings Rate
through Supply-Side Policy
• Numerous efforts and proposals made to
increase national savings rate through supply-
side policy
– Efforts and proposals aimed at increasing incentives
for households and businesses to save and invest
1. 1981 tax law
– Accelerated tax write-offs for new investment by businesses,
greatly reducing corporate income taxes
– Provided tax breaks to households placing income into
individual retirement accounts (IRAs) and 401(k) accounts
2. Capital gains tax and taxes on dividends, received by
shareholders, have been reduced
3. Repeated proposals for consumption tax to replace current
personal income tax
– Like a national sales tax, a consumption tax taxes only share
of household income spent on consumer goods and services;
does not tax portion of income saved
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 An Improvement in Labor Productivity

• Labor productivity
– Total output per average work hour,
calculated as GDP divided by number of work
hours
– Hinges on type and amount of capital and
technology used in conjunction with labor
– Also depends on human capital

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 An Improvement in Technology
• Technological advance depends on research and development (R&D)

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 Research and Development
• Government policies can be used to
encourage research and development
– Government can increase university funding
available for research and offer tax breaks for
businesses that engage in research and
development
– Government can provide patent protection to
developers of new products
• Patent
– Government grant of exclusive rights to use or sell new
technology or product for period of time
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 Information Technology
• Nowhere has technological advance been more prominent than in area of
computers

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 A Decrease in Regulation
• Government regulates business in variety of ways,
including:
– Protections for consumers of pharmaceuticals, food, and
manufactured goods
– Safeguards for workers in industry
– Protection of environment
• In light of recent deaths caused by unsafe tires and
certain pharmaceutical drugs, necessity for wisely
developed government regulations is clear
• On the other hand, unwise and unnecessary regulation
merely increases business costs and decreases output
– Problem is recognizing which regulations are harmful and which
are beneficial

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 The Twenty-First Century?
• Market-oriented growth policies of
Western industrialized world likely to
persist for at least near future
– However, may be cyclical movement of
philosophy from restricted government role to
expanded government role and back again,
as dissatisfaction with drawbacks of either
extreme becomes evident

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 The Formerly Socialist Industrialized
World: Economic Transition

• Formerly socialist economies of Eastern

and Central Europe now undergoing
economic transition toward capitalism
– Transition has achieved varied level of
success, as evidenced by diverse economic
growth rates
– Most prominent elements of transition to
capitalism have been movement toward
market-determined prices and process of
privatization, as well as development of
entrepreneurship
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Economic Growth Rates

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 Market-Determined Prices
• Under pure socialism, government sets prices of
goods and services
– Prices had traditionally been set artificially low in
socialist economies of Eastern Europe
• Artificially low prices operate like price ceilings, and result in
shortages

• Prices of most items have been allowed to rise

to market-determined levels in most Eastern
European countries
– In other words, decontrol of prices has occurred
• Governments no longer set prices
– Because wages have not always risen as rapidly as
prices, purchasing power of consumers has declined
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 Privatization
• Transfer of government-owned enterprises
or responsibilities to private sector
• Throughout Eastern Europe, governments
have owned everything from industry and
businesses to agricultural land, energy
facilities, agricultural marketing boards,
and transportation networks
• Process of privatization presumes that
private ownership of means of production
enhances efficiency and growth
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 Effects of the Transition
• Objectives of transition from socialism to
capitalism throughout formerly socialist
industrialized world are greater efficiency and
growth
– But transition has posed many problems for people:
• Inflation has made it difficult for consumers to afford basic
necessities
• Farmers have been hit hard by increases in prices of inputs
such as fertilizer, and prices they receive for food products
often still remain artificially low
• Workers have been laid off in defense industries, government
jobs, and privatized businesses, and other workers frequently
have not been paid
• Corruption is often widespread, and organized crime is
sometimes rampant

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 The Twenty-First Century?
• Twenty-first century is a question mark
– Although policies of liberalization will undoubtedly
continue, struggles and dissatisfactions of ordinary
people may slow down or change nature of transition
• In some countries, transition may even be reversed
– Opinion polls show that large shares of population wish to
return to the ―old days,‖ when they were provided with housing,
jobs, child care, and medical care

• Critical issue in transition to freer-market

economies in Eastern and Central Europe is
safety net for people
– Governments must ensure that people’s basic needs
are met

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The Less-Developed World: Economic Reform

• Much of less-developed world is

undergoing process referred to as
economic reform
– Developing countries adopting policies that
move economies toward freer markets; are
engaged in liberalization
– Economic reform predominant in 1990s and
2000s has roots in international debt crisis of
1980s
• That crisis has roots in world economic conditions
of 1970s

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 The 1970s: Oil Crisis
• Most significant economic events of 1970s
began with restriction of oil supplies by
Organization of Petroleum Exporting
Countries (OPEC), Arab oil embargo, and
quadrupling of oil prices between 1973
and 1974
– Among less-developed countries (LDCs),
limited number of OPEC countries received
massive increases in earnings from oil
exports; non-oil-exporting countries suffered
huge increases in spending for oil exports
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 Effects of the Oil Shock
• Effects of oil shock were threefold:
1. OPEC nations began process of ―recycling‖ oil
revenue; deposited much of oil revenue in U.S. and
European financial institutions
2. Oil price increase caused generalized inflation, and
subsequent recession, throughout much of world
3. Combination of reduced export earnings and
increased oil import expenditures caused LDCs to
borrow from International Monetary Fund (IMF), as
well as from commercial banks

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 The 1980s: Debt Crisis
• Second phase of borrowing funds when OPEC and
Iranian oil embargo again sent oil prices soaring in 1979
occurred at time of great concern in U.S. over inflation
that was largely generated by escalating oil prices
– High inflation rates persisted until early 1980s, when Federal
Reserve engaged in contractionary monetary policy
• Consequences:
1. Inflation brought under control, but at expense of skyrocketing interest
rates and consequent U.S. recession that later spread worldwide
2. Since LDCs started borrowing from commercial banks, as opposed to
IMF, larger proportions of lending agreements stipulated variable
interest rates, which were rising very rapidly
» Interest payments by LDC borrowers increased as well
3. Rising interest rates in U.S. had secondary effect of pushing up value
of dollar
» Rising dollar made LDC payments for oil imports even more
difficult because oil is valued in dollars

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 LDCs and Borrowed Funds
• By 1988, less-developed countries had
borrowed more than a trillion dollars
– In many LDCs, however, borrowed funds were
grossly misused
• Lenders had so much lending capacity that they neglected to
take adequate care in who they lent to and for what purpose
– Another problem was capital flight
• Process whereby borrowed funds are reinvested in financial
markets or real estate abroad
– Corrupt government officials or businesspeople with access to
borrowed funds often invested these funds overseas, rather
than using them for local projects
» When governments fail to invest borrowed funds
productively, naturally hampers ability of borrowing
countries to repay debt

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 Debt Repayment
• Amount of money that must service debt
(interest payment plus repayment of
principal) represents large expenditure in
any particular year
– Debt service of LDCs meant that significant
proportion of gross national income was
transferred out of country
• Since gross national income of LDCs is typically
small, any expenditures toward repaying debt will
directly harm well-being of people

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 Debt Repayment (cont.)
• In addition to problem of allocating income for
debt servicing, is a problem of form that
transfer must take
– Debt repayment must be made in form of currency
initially borrowed; thus, repayment must typically be
in U.S. dollars or in currency of other major countries
(i.e., ―hard currency‖)
• LDCs have very limited means of obtaining hard currency
with which to make payments
– May earn foreign currency through:
1. Exports to other countries
2. Foreign investment by other countries and international
assistance
3. Continually borrowing to repay past debts

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The 1990s: Economic Reform
• Final phase of debt crisis occurred as many
countries were forced by inability to meet
payment schedules to seek financial assistance
from International Monetary Fund
– IMF assistance has typically involved conditionality,
forcing countries to undertake vast number of
economic reforms as condition for assistance
• Reforms include requirements that government:
– Reduce spending
– Privatize government enterprises
– Allow food and other prices to rise to market levels
– Reduce controls on foreign trade and investment

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 The Twenty-First Century?
• Less-developed countries have had mixed reactions to
economic reforms
– In many countries, privatization has resulted in massive layoffs of
public-sector employees
– In other countries, rising food prices have been met with riots
– In still other countries, economic reforms have created rapid
economic growth and national prosperity
• Hoped that economic reform throughout less-developed
world will lead to economic growth and that benefits of
growth will reach poor, but at least in short term, poor
are ones who suffer most
– Critical issue is existence of adequate safety net for poor
• Many rejecting notion that economic reform, along with
capitalism and market-based economy, will ultimately
benefit poor
– Turning toward versions of socialism in reaction to failures of
conservative policy
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 The Economic Left and the Economic Right

• THE ECONOMIC • THE ECONOMIC

LEFT (Liberal) RIGHT
– See marketplace as (Conservative)
imperfect and believe – Maintains that free
that markets are not markets are efficient
necessarily equitable, and provide proper
and sometimes not incentives for economic
even efficient prosperity and growth
– Prefer more to occur
government regulation – Prefer less government
regulation

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