Macroeconomic choice
In macroeconomics, choice focuses on the decisions of society. This can have elements of philosophy, economics and politics. To begin, we need a way to categorize the types of statements we can make.
Positive economics includes statements that are testable or factual. This includes descriptions of data movements and simple theoretical relationships. More complicated analysis with data, and use of advanced statistics also fall under positive economics. This is because they provide testable predictions.
If your marginal tax rate is 20% then a raise of $1000 that changes nothing else about your tax situation will lead to a take home increase of $800. It is likely that the additional take home may be different from person to person (family to family), due to other facts and circumstances.
Positive economics also includes scientific laws, which means statements that describe patterns in nature with consistent predictability. This is different from a legal law, which are rules established to regulate behavior. We will see a few laws in the remainder of this chapter, and they are all critical concepts.
Normative economics is about what “should” be done, what “may” happen when a policy is enacted. Value judgments and opinions are exclusively normative economics. Any statement that is not testable is normative. Often normative statements depend on context.
As an example, saying that any of the economic systems (which will be outlined next) is better than the others is a normative statement. You may say that specific economic measurements are higher or lower under one system, which would be positive statements. General statements about rankings or desirability without any data or testability will be normative.
Economic systems
We have three key questions that are the macroeconomic elements of choice
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What to produce?
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How to produce?
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For whom to produce?
Broadly speaking there are three major categories of systems that can be used to make these decisions. In each case we will discuss the example of the production choice of a farmer, and how it would work in that system.
Each system has a different balance between efficiency, equity and adaptability. Efficiency has already been discussed, allocative and productive may be possible and they can absolutely be separated. Equity is fairness, which does not necessarily mean equal. Equity also has to do with access to opportunities rather than just financial resources such as income and wealth. Adaptability is the ability to adjust to things such as technology, changes in demand or resources, or problems such as recessions or pandemics.
Market economies
The market economy delivers on productive efficiency and adaptability. The seeking of profits drives innovation, technological development, and cost reductions. Changes in prices also lead to responses by firms and consumers, making a variety of products available for consumers.
The weaknesses of the market economy relate to equity and allocative efficiency. The distributions of wealth and income can have significant inequality, as well as exploitation of consumers and excessive risk taking. Problems that markets have trouble with, such as traffic congestion and pollution, may cause social harm that is not addressed by this allocation system.
In a market economy farmers decide what to plant, based on expected yield, costs and market prices. They have control over where, how and who to sell to. They can choose to not sell and may, for example, if it raises the price of other units they have for sale. Farmers can plant nothing, for example for crop rotation purposes, if they expect it will lead to more profits.
Command economies
Command economies provide equity and social stability. Employment is guaranteed and basic needs are provided for. Under these systems it is also easier to coordinate resources, for example building construction or large scale projects such as dams. This can lead to allocative efficiency, if the production choices match the desires of society.
The weaknesses of the command economy are the strengths of the market economy. Without market prices, there is a lack of incentives for innovation, cost reductions, and providing options for consumers. This leads to inefficiency and low productivity. Large bureaucracies can also lead to misallocation of resources, waste, and low levels of adaptability.
Under a command economy a farmer is told what to do by the government. At a minimum they are told what to grow, they may also be told how to do it and provided with the equipment and other supplies to do so. Any crops grown are not sold at a market, but rather distributed in a way the government decides.
Mixed economies
Mixed economies unsurprisingly sit in the middle on efficiency, equity and adaptability. They allow the market to provide efficiency with government intervention to target market failures, inequality and social priorities. When crises arise, they use both market signals and government policy to respond. The outcomes can vary significantly, depending on choices regarding trade offs between efficiency versus equity and adaptability versus equity.
Farmers will often have some choice over what they grow and how they sell it, but there may be government intervention. Certain crops may be banned or restricted, others may be subsidized. Sales can be completely market based or through organized systems with government involvement. The government may also participate in these product markets, for example to prevent prices from being low enough to drive farmers out of business.
Real life examples
The command economy and market economy are two extreme ends of a spectrum, with market economies in the middle. There are no real life examples of a pure market economy. Command economies currently exist in two countries, Cuba and North Korea. Every other country is a mixed economy.
China used to be a command economy, but this century they are firmly a mixed economy. There is still significant government involvement in production and ownership of corporations, but they have extensive market activity and expanded consumer choice compared to the past.
The United States and Singapore are examples of mixed economies that are close to market economies. They are more business friendly, so there are fewer limits on private activity. The government provides fewer social programs and there tends to be higher levels of inequality.
Finally, Sweden and France are examples of market economies that have higher levels of government involvement. Most goods and services are provided by private markets, however there are more social programs and lower levels of inequality. Specific examples of government involvement in those two countries specifically are universal health care systems, which are fully paid for by the government, and university-level tuition, which are heavily subsidized by the government.
The choice between these systems are a reflection of factors such as social preferences and historical context. The primary responsibility for the AP exam is to understand the key differences between these systems, rather than any story for a specific country.