5. Economic systems

Whenever people gather in a community, they deal with a few universal economic problems. These fundamental questions are as crucial today as they were at the dawn of human civilization. Every human society – whether it is an advanced industrial nation, a centrally planned economy, or an isolated tribal society – must solve three fundamental and interdependent economic questions.

• What goods and services are to be produced, and in what quantities are they to be produced?

• How are these goods and services to be produced?

• Who will receive and consume these goods and services?

The first basic choice refers to what goods a society should produce and in what quantities. Every economy has limited resources at its disposal but the goods and services wanted by its people are numerous. With the limited resources society can produce all the things its people want. So an economy faces the problem what combination of goods and services should be produced? The nature of the combination depends on the consumers’ choices and preferences reflected in market prices or in government policies.

A second basic choice relates to how to produce goods and services. Most goods can be produced in more than one way by using resources in different quantities and combinations. It is often possible to vary the factor combination in manufacturing. Any society decides how it will organize its scarce resources in order to use them efficiently. As the economy has to economize its limited resources it has to make a choice between various production methods to produce different goods.

No one can get all he wants. Whatever is produced in an economy it cannot be sufficient to meet everybody’s wants. So a problem arises who will get and how much. This is the problem of distribution of a nation’s wealth among different groups.

Production of goods and services is the result of the joint efforts of the owners of the four factors of production: land, labour, capital and entrepreneurship. So the total national income is distributed among the owners of these factors of production. There is no system by which goods and services may directly be distributed among the factor owners. What they get is the money income in the form of rent, wages, interest and profits. With this income they buy the goods and services. How much wage earners and profit earners can buy, land or capital owners can buy depend upon their income. So it is a problem of national income distribution.

The way that a country uses to solve three basic questions is based on its economic system. An economic system is a mechanism that deals with the production, distribution and consumption of goods and services in a particular society.

There are four main types of economic systems present in the world: the traditional economy, the command economy, the market economy, and the mixed economy.

• The traditional economy is an economic system in which decisions about what, how, and for whom questions are made on the basis of customs, beliefs, religion, habit, and tradition.

People’s economic roles are the same as those of their parents and grandparents. The ways they produce clothing and shelter are almost exactly the same as those used in the past. Traditions decide what these people work for a living, how their work is performed and who gets what is produced in such an economy.

It has an advantage over other systems, in that there is little disagreement among members because relatively little is disputed. However, it restricts individual initiative and has a lack of advanced goods, new technology, and economic growth.

• The command economy is a society where the government institutions make all decisions concerning what will be produced, how it will be produced, and for whom it will be produced.

In a command economy, a central authority or agency draws up plans that establish what will be produced and when, sets production goals, and makes rules for distribution. The government owns a considerable portion of the means of production, thus they are publicly owned; it also owns and directs the operations of enterprises in most industries; it is the employer of most workers and tells them how to perform their work.

A hard working citizen has no chance to benefit from his extra work because he cannot increase his standard of living any greater than it currently is and he will earn just as much as a person who makes little or no effort.

• The market economy (or free enterprise economy) is an economic system in which the decisions of many individual buyers and sellers interact to determine the answers to the questions of What, How and Who.

In a market economy the fundamental economic questions are answered in the marketplace by the interaction of buyers and sellers. The question of what to produce may be based on what trend is popular right now. The producers create a product that they think they will sell well to the consumers in hope to make a profit. The question of how to produce is usually based on the producer's choice. They might decide to produce a product with more workers or with machines and computers to save on labour costs*. The question involving for whom to produce is based on the consumers who decide what they want or need and what price they are willing to pay for it.

There are several essential elements in a market economy. One of these is private property – the right of individuals and businesses to own the means of production. Unlike command economy with its public property, in a free market economy the major factors of production are privately owned. Private ownership gives people the incentive to use their property to produce things they will sell and make profits.

This desire to earn profits or the profit motive is a second ingredient in a market economy. The profit motive encourages sellers to produce commodities at the lowest possible cost.

• The mixed economy is an economic system that answers the three economic questions both in the marketplace and in the government*.

A mixed economy contains both privately and publicly owned enterprises and relies on the market but with a large dose of government intervention. A mixed economy usually involves producers working closer with the government to achieve economic goals.

Since no country in the world have either type of economic system in its pure form, all major economies are mixed ones because markets as well as government decisions* play a role in answering the basic economic questions. The blend of market and government participation is different in different countries with mixed economies. The optimal level of government interference remains a problem which is of interest to economists.