Chapter 1 Outline
A. Factors Needed for Successful Transition to a Market Economy
1. A price system must have a reasonably stable price level.
2. A price system must have an extensive legal system that creates private property and defines the rules of economic transactions.
3. The legal system must be broadly obeyed and generate a climate of trust.
4. Prices must be allowed to ~~uctuate in response to changes in demand and supply.
5. The rewards and penalties of the price system must be allowed to encourage and motivate decision makers.
B. Inflation
1. Prices under central planning were typically low because they were held downby law, plan, and inertia.
2. As prices were freed, the suppressed inflation exploded, hidden unemployment became open, new unemployment arose, and production fell dramatically.
3. Significant inflation damaged the information function of prices.
C. Flexible Prices
1. Most of the countries of Central and Eastern Europe have allowed the pricesof many goods to adjust to demand and supply conditions.
2. Prices of essentials have been held down for humanitarian and political reasons.
3. Subsidies to state-owned enterprises have continued in order to prevent unemployment from increasing beyond its already high rates and to continue to provide social services.
D. The Establishment of Private Property Rights
1. Many transition economies have sprouted significant private economic activityin a short time.
E. Incentives
1. Countries have used different schemes in order to privatize state-ownedenterprises.
a. Without privatization, the managers do not have strong incentives to produce in a cost-effective manner.
F. Legal System
1. Bankruptcy laws must be developed in the transition economies.
a. This is one way to allow economic resources to be moved from owners who are not using them profitably to other owners who may do a better job.
2. The disruptions caused by introducing a new system have created a climate of lawlessness in some transition economies.
a. This reduces the security of property rights and inhibits economy activity by domestic and foreign investors.
G. Additional Thoughts on Transition Economies
1. The experiences of transition economies as they have moved toward marketsystems have been diverse.
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