Chapter 2
Political Environment
and
Economic Systems
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Learning Objectives
Understand the history of economic thought
Analyse how an economic system works
Explain the real-life situations vis-á-vis economic
systems in different countries
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ECONOMIC SYSTEMS
Capitalism: Adam Smith & The Wealth of Nations
(1776)
Communism: Karl Marx & Das Kapital (1886)
Mixed Economy
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The Free Market of Adam Smith
“The uniform, constant and uninterrupted effort of every
man, to better his own condition, the principle from which
national and public as well as private opulence is originally
derived, is frequently powerful enough to maintain the
natural progress of things toward improvement, in spite
both of the extravagance of government, and of the
greatest errors of administration.”
- Adam Smith
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How Does This Happen?
Buyers and sellers negotiate prices in a free market
and carry out transactions of buying and selling
that leave all parties mutually better off.
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Capitalism
System based on Free market
Capital: owned by a minority of individuals
Private Property rights: legal right to use this capital for
private gain
Market system (Supply & Demand factors)
– To determine distribution of goods & services
– To allocate resources
– To establish income levels, wages, rents & profits
– Govt. Role is limited
– Ex: USA, UK etc.
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A Startling Idea
Economic order can emerge as the unintended
consequence of the actions of many people, each
seeking his own interest.
-Milton Friedman
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Communism According to Marx
The natural evolution of communism after capitalism
State owns all factors of production and distribution.
Ex: Cuba
The workers reap the profits from their labor rather
than subsistence wages
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Question?
Why did the people of the United States
choose markets as the means to organize
economic activity?
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MIXED ECONOMY
India’s experience since the First Five Year Plan
Equal importance to private and public sector. However,
major factors of production and distribution are owned
and managed by the state.
Success or Failure?…Debatable issue
Ex: India, France and Holland
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POVERTY
Absolute Poverty:
Measured as total number living below a specified min level of
real income/poverty line(people who are unable to satisfy
basic needs)
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Human Poverty Index (HPI)
UNDP HPI measures poverty in terms of 3
deprivations-of life(percentage of people unlikely
to live beyond 40 years),of basic education(as
measured by % of adults who are illiterate), & of
overall economic provisioning(% of people without
access to health services & safe water+% of under-
weight children under 5)
[Source:HD report 2001, UNDP]
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Poverty characteristics
Rural Poverty, Women & Poverty, Ethnic Poverty
Rural Poor as % of population is 79%(India),
80%(Malaysia), 37% (Mexico), 96%(Kenya).
Women make up majority of world’s poor.
Minority ethnic groups are poor (Latin America
etc.
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INCOME DISTRIBUTION AND PLANNING -
POLICY OPTIONS
1. Altering the distribution of income to change
factor prices (eg: relative price of labor, ensuring
min.wages)
2. Progressive Distribution of Asset Ownership
(Classic case: Land reforms): Purpose is to
transform tenant cultivators into small holders
who will then have incentive to raise production
and improve their income.
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INCOME DISTRIBUTION AND PLANNING -
POLICY OPTIONS
3. Reducing income distribution at the Upper levels through
progressive income and wealth taxes (Rich required to
pay larger % of their income in taxes than poor and high
indirect taxes on cigarettes and beer)
4. Direct Transfer Payments & Public Provision of Goods and
services (Ex: Public Distribution system in India).
Subsidies for farmers, Pension and policies to keep price
of essential foodstuffs low.
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INDIAN SCENARIO
The impact of planning strategy of the last 2
decades on social sector indicate significant
improvements - yet, there is need to improve the
quality of life. Govt expenditure for social services
has more than doubled from Rs.11,631 crore in 95-
96 to Rs.35,478 in 03-04. As per the Planning
commission estimates, there was a significant
decline in proportion of people living below
poverty line, from 51.3% (77-78) to 26.1% (99-00).
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COUNTRY CASES
Cases: US & CANADA
INDIA & POLAND
CUBA & VIETNAM
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