| Chapter 1 Outline |
| IV. TRANSITIONS TO A MARKET ECONOMY: SOME EXPERIENCES |
| 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. |