Topic:

Nations and societies use different methods to determine how to use their limited resources
efficiently. That means different countries will try to solve the problems of what to produce,
how to produce and for whom to produce in different ways. The method used by the nations
to answer these questions is its economic system.

In this article, we'll explore the definition and functions of economic systems, the different
types of economic systems, and provide an overview of each type with real-world examples.

Definition

An economic system is a way how a society produces and distributes goods and services. It
involves how things are made, who gets to make them, how they are distributed, and how
people get access to them. It's like a set of rules that everyone in society follows when it
comes to money and trade.

Economics system are the means by which countries and governments distribute resources
and trade goods and services. They are used to control the five factors of production,
including: labor, capital, entrepreneurs, physical resources and information resources. In
everyday terms, these production factors involve the employees and money a company has at
its disposal, as well as access to entrepreneurs, the people who want to run companies or start
their own businesses. The physical materials and resources needed to run a business, along
with the data and knowledge companies use to be successful, are also factors in production.
Different economic systems view the use of these factors in different ways

Functions of an Economic System

There are four main functions of an economic system, which are usually presented in the
form of questions called economic problems. The answers will determine what type of system
the society has:
● What to produce?
● How much to produce?
● How to produce?
● Who gets what?

What to produce?
The most essential job of an economy is to determine what commodities and services will be
produced. And while demands are limitless, resources are not. As a result, society is
confronted with the challenge of selection.

One of the first things that society then has to figure out is what to produce. The provided
resources are used to produce various items and services in order to satisfy the greatest
number of consumer desires. Therefore, the community must choose between consumer and
capital products.

Things become a bit more complicated when talking about consumer goods since a choice
must be made between products for general consumption and those for luxury.

How much to produce?

Should production be at maximum potential or should there be some jobless people and
wasted resources? How much to manufacture is governed by customer demand; unless
someone purchases a particular item, manufacturing of that item would stop and a surplus
would accumulate.

How to produce?
The next main issue to tackle is the issue of how to produce. In order to help figure out the
answer, there are a few things that are taken into account before making a decision:
● Which commodities will be manufactured in public vs private sector?
● Which companies will be hired on to produce the commodities, and how many
resources will be given to them to use for production?
● Which manufacturing methodologies will be adopted to ensure maximum output?
The community should adopt a style of production organization that can adequately meet the
greatest number of people's desires.

Who gets what?

The allocation of output in society is another critical role of an economic system. The
following criteria must be examined in order to ensure an equitable and efficient allocation of
production.
 ● How output is allocated between households and the government.
● The ideals of fairness and efficiency
In a capitalist system, for example, allocation is done via the pricing mechanism, which
produces disparities. Because of this, income plays a large role in who gets what.
Note:
Capitalism is an economic system wherein individuals own and manage property in
accordance with their desires, and free market forces establish prices in a way that fits
society's best interests.

The pricing mechanism is the method through which the market forces of supply and
demand determine commodity prices.

Types of Economic Systems

Economic systems are classified into four types:
● command economic system
● market economic system
● mixed economic system
Each system has its advantages and disadvantage

Command Economic System

A command economy is an economic system in which the government makes all the
economic decisions regarding the production, distribution, and consumption of goods and
services.

The essential economic choices in command economies are made by the governments. The
government decides which commodities will be produced and at which level and at what price
they will be sold. The aim of a command economy is to meet all needs of society and
prioritize social welfare over profits.

The advantages of a command economy or planned economy are that central planning allows
the elimination of market failures, and in theory, better allocation of resources, prioritizing
social needs over profits. Disadvantages, on the other hand, include limited consumer choice
and a lack of incentives for innovation.

Ex:The Soviet Union was a command economy where the government had complete control
over the economy, and the planning was done by the central government.
Advantages
● Economic activities are free from instability (the economy will be more stable)
● Income and wealth are equally distributed
● Every citizen is provided with minimum requirements like food, clothing, health
and education
● The nation has command over activities
● Economic activities are well planned and targets are fixed.
● Welfare motive: most people will be able to afford the goods and services.
Disadvantages
● Less consumer choice as it provides only limited range of goods and services
● Absence of competition leads to reduce quality of products
● In most command economies, there is a shortage of goods which push up the
prices of most essential goods
● Higher degree of movement influence leads to beaurocracy and its draw backs
like corruption, bribery and development of shadow market (black market).

Market Economic System

Also referred to as capitalism or laissez-faire economies, market economies are economic

systems wherein market decisions are governed by price fluctuations that occur when sellers
and consumers interact to set the sale of products.

Decision-making in a market economy is dictated by price fluctuations that happen between

producers and consumers. Main characteristics of the market economy are private ownership,
competition, and minimum to no government intervention.
The amount individuals pay for items is determined by the law of supply and demand. One
advantage to this type of economy is that buyers are able to locate what they want and
purchase as many of the items as they want and can finance. An issue is that there is no
pricing stability, and enterprises that are mishandled can fail.

Ex:The United States is a market economy where businesses and individuals make decisions
based on their own self-interest, and the government does not play a significant role in the
economy.
Advantages
● Consumers get a wide range of goods.
● Producers are encouraged to produce what consumers want, leads to innovation
● Consumers and producers have more freedom of choice
● It encourages competition between firms leading to greater efficiency.
Disadvantages
● Wealth generates wealth, leading to greater inequalities between rich and the
poor.
● As there is less interference by the government, business tend to employ
methods which may cause environmental damage
● Capitalist Economy does not fully take into account the issues like health and
safety.
● It does not provide public goods and merit goods.
● Use of modern equipment leads to unemployment with the people feeling socially
insecure

Mixed Economic System

A mixed economy is an economy that combines parts of command and market economies

A mixed economy combines elements of command and market economies. All of the
societies present-day have features of both systems and are frequently called mixed
economies, despite the fact that almost all societies tend to lean toward one form of the
economy more than the other.

A mixed economy aims to reduce the drawbacks of both systems while implementing the
advantages. In a mixed economy, government can intervene in a key sectors like education, or
healthcare while leaving other, less important from the perspective of a wellbeing of the
society, sectors to private companies.The increasing government involvement also ensures
that less competitive individuals are looked after. This eliminates one of the drawbacks of a
market economy, which favors only the most successful or inventive.

Ex:Sweden is a mixed economy where the government provides social services like
healthcare and education, but the private sector drives the majority of the economy.
Advantages of mixed economy
● The presence of price mechanism helps to allocate the scarce resources
effective and efficiently
● Effective utilization of economic resources due to prior planning
● The presence of freedom of choice , profit motive, competition etc increase the
economic efficiency in the country
Disadvantages of mixed economy
● Conflict between the sectors and its aims to make difficult to operate system
● Social evils like corruption and black markets can rise
● Excessive control over private section and government dictatorship will discourage
private individuals and firms
● Dependence on the government kills efficiency of private sector

Risks and challenges facing an economic system

Command economy
1.Lack of incentives for innovation and entrepreneurship: In a command economy, the lack of
profit motive and competition significantly reduces incentives for innovation and
entrepreneurship. This can lead to stagnation in product development and economic growth.
2.Inefficient allocation of resources: The lack of market signals, such as prices, often leads to
inefficient allocation of resources. Government planners may not have the information needed
to make optimal decisions, leading to overproduction or underproduction of goods. This
challenge is exacerbated by the lack of a price mechanism that can guide production and
consumption decisions in a market economy.
3.Limited consumer choice: Government control of production often results in a limited range
of goods and services, which may not match consumer preferences. This can lead to popular
discontent and mismatch between supply and demand.
4. Bureaucratic inefficiency: The centralized nature of decision making in a command
economy can lead to bureaucratic inefficiency and slow response to economic changes. This
can lead to delays in production, distribution and adaptation to new economic conditions.
5. Corruption and abuse of power: With significant economic power concentrated in the hands
of government officials, there is a higher risk of corruption and abuse of power. This can
hamper economic efficiency and lead to inequitable distribution of resources.

Ex:
North Korea: North Korea is a classic example of a command economy, where tight
government control over every aspect of economic life has led to chronic food shortages,
economic inefficiency, and isolation from the global economy.

Soviet Union (Historical Example): The Soviet Union faced significant challenges due to its
command economic structure, including inefficiencies in production and distribution, which
contributed to its eventual collapse. The lack of market signals and incentives for innovation
led to economic stagnation and shortages of consumer goods.

Cuba: Cuba has maintained a command economy since 1959. Despite achieving high levels
of literacy and access to health care, the country has also faced criticism for restricting
political freedoms and violating human rights. The economy has struggled with inefficiency
and shortages of consumer goods, partly due to US sanctions and domestic economic policies.

Market economy
Economic Inequality: One of the main challenges in a market economy is its tendency to
create significant economic disparities. Free markets can lead to the concentration of wealth
in a small segment of the population, leaving others with limited access to resources and
opportunities. This inequality can lead to social tensions and reduced social mobility.
Market Failure: A market economy can suffer from failures when markets do not allocate
resources efficiently. Examples include public goods, externalities (e.g., pollution), and
monopolies.
These failures often require government intervention to correct inefficiencies and ensure fair
competition.
Cyclical Instability: A market economy is prone to economic cycles of booms and busts.
These cycles can lead to periods of high unemployment and inflation, requiring monetary and
fiscal policies to stabilize the economy.
Environmental Degradation: The focus on maximizing profits in a market economy can lead
to overexploitation of natural resources and environmental damage. Without a legal
framework, businesses may not take environmental costs into account in their operations.

Short-term focus: The emphasis on short-term profits in a market economy can sometimes
lead to short-term decision-making that is detrimental to long-term sustainability and social
welfare.

Ex:United States: While the United States is more accurately described as a mixed economy,
it leans toward market principles. The 2008 financial crisis highlighted the weaknesses of
market-driven economies, where deregulation and risky financial practices led to a global
recession.
Hong Kong: Known for its free-market policies, Hong Kong has faced challenges related to
income inequality and housing affordability, highlighting the potential downsides of minimal
government intervention in certain areas.

Mixed economy
Balancing government intervention and market freedom: One of the main challenges of a
mixed economy is finding the right balance between government intervention and market
freedom. Too much government control can stifle innovation and efficiency, while too little
can lead to market failure and social inequality.
Economic inefficiency: Mixed economies can suffer from inefficiency due to the dual nature
of their economic systems. The coexistence of public and private sectors can lead to
misallocation of resources and bureaucratic red tape.
Regulatory complexity: Regulations in a mixed economy are intended to protect consumers
and the environment, but they can also impose significant costs on businesses, potentially
leading to reduced competitiveness and innovation. The presence of both private and public
sectors can lead to complex regulatory environments that can hinder business operations.
Political Influence and Cronyism: In a mixed economy, the interaction between government
and business can lead to cronyism, as businesses seek favorable treatment through political
connections rather than competing in the market.
Social Welfare and Taxation: The need to fund social welfare programs in a mixed economy
often leads to higher taxes, which can be a burden on businesses and individuals. This can
reduce incentives for investment and economic growth.

Ex:United States: The US government intervenes in the economy through regulation,

subsidies, and public ownership in certain sectors such as defense and the postal service.
However, this intervention can sometimes lead to regulatory capture, where industries
influence regulations in their favor, potentially distorting competition in the market.

European Union: The EU's mixed economy model includes strict regulations on consumer
protection and the environment. While these regulations are beneficial to social welfare, they
can increase the operating costs of businesses, affecting their global competitiveness.
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Question:
1.What role does the economic system play in society?

2.Does every society have an economic system?

3.Can a society function without an economy?