2. How did the oil price shocks affect the world economy? Describe the changes in terms of what, how and for whom to produce.

Oil is an important commodity in modern economies. Oil and its derivatives provide fuel for heating, transport, and machinery and inputs for household products. The use of oil is increasing steadily. Economic activity was organized on the assumption of cheap and abundant oil.

In 1973 the main oil-producing nations that belong to OPEC decided to raise the price for which their oil was sold. Consumers of oil tried to economize on its use, OPEC correctly forecast that cutbacks in the quantity demanded would be small since most other nations were very dependent on oil and had few substitutes for oil. It was very profitable for OPEC members. The dramatic price increases of 1973-74 and 1978-80 are known as the OPEC oil price shocks.

Consider first how the economy produces goods and services. After dramatic price increases every firm tried to reduce its use of oil based products. Chemical firms developed artificial substitutes for petrol; airlines looked for more fuel-efficient aircraft; electricity was produced from more coal-fired generators.

Consider what is being produced? Firms and households reduced their use of oil-intensive products which became more expensive. Households switched to gas fired central heating and buy smaller cars. High prices not only reduced the demand for oil related commodities; they also encouraged consumers to purchase substitute commodities. Higher demand for these commodities increased their price and encouraged their production.

The for whom question in this example has a clear answer. OPEC revenues from oil sales increased from $35 billion in 1973 to nearly $300 billion in 1980. Much of their increased revenue was spent on goods produced in the industrialized Western nations. The rise in oil prices raised the buying power of OPEC and reduced the buying power of oil-importing countries such as Germany and Japan. The world economy was producing more for OPEC and less for Germany and Japan. The OPEC oil price shocks example illustrates how society allocates scarce resources between competing uses.

3. What are the main types of economic systems? Characterize each of them in detail. What is the most prevalent type? Why?

There are three categories of economic systems: traditional, command and market economies.

The Traditional Economy.

The answers to the What, How and Who questions are decided by tradition in traditional economies.

Traditional economic systems are usually found in the more remote areas of the world. Such systems may characterize isolated tribes or groups, or even entire countries. They are less common today than they were in earlier decades. Typically, in a traditional economy, most of the people live in rural areas and engage in agriculture or other basic activities such as fishing or hunting. The goods and services produced in such a system have been produced for many years or even generations. They are produced as they always have been. In short, what products and how they are produced in the traditional society are determined by very slowly changing traditions.

Since there is little produced, there is little to go around. Most individuals live near a subsistence level: They have enough to sustain them but little more than that. When a surplus exists, it will be distributed traditionally. For example, the main of the produce might go to a tribal chief or large landholder, while the balance is distributed according to custom.

The Command Economy.

Countries such as the Soviet Union, Albania, and China are examples of command economies. Groups of high-level technicians, made up of engineers, economists, computer experts and industry specialists known as "planners," advise political leaders who develop and implement a plan for the entire economy. Essentially, it is the planners who decide what goods and services will be produced. Planners decide who will receive the goods and services produced. By setting wage rates for everyone, as well as interest rates, profits and rents, the planners directly answer the question: Who will receive the goods and services produced? In command economies factories, farms, stores, and other productive resources are government owned.

The Market Economy.

In a market economy, or free enterprise system as it is sometimes called, it is likely that if consumers really want smt, they will get it.

A market, or free enterprise economy is one in which the decisions of many individual buyers and sellers interact to determine the answers to the questions of What, How and Who.

One of the essential elements in a market economy is private property. "private property" is the right of individuals and business firms to own the means of production. In a market economy the means of production are owned by private individuals. People use their property to produce things that will sell and earn them a profit.

This desire to earn profits is known as the profit motive, it provides the fuel that drives sellers to produce the things that buyers want, and at a price they are willing to pay.

The profit motive also gives sellers the incentive to produce at the lowest possible cost. Because lower costs enable them to (1) increase their profit margins, the difference between cost and selling price, or (2) help to undersell the competition, or (3) both. Producers who produce the things that buyers demand can earn profits.

Mixed Economies.

There are, however, no "pure" market economies in the world today. Markets are responsible for most economic decisions in this country, government has been playing an ever-widening and important role. This blend (смесь) of market forces and government participation is known as mixed economies.