Chapter 4

Resource allocation in different economic

systems
4.1 What are economic systems?
The fundamental problem of scarcity requires
choices to be made. The problem common to all
economies: low-income, middle-income and
high-income. The choices that are made and how
they are made and how they are made is
determined by the economic system of a
particular country. A country’s economic system
identifies the means by which households, firms
and the governments make decisions relating to
the three resource allocation systems:
1) What goods and services are to be
produced?
2) How are the goods and services to be
produces?
3) Who should receive the goods and
services?
Traditionally, economists have recognised three
main types of economic system: The market
economy, the planned economy and the
mixed economy. In market economies,
resource allocation decisions are largely driven
by the market mechanism, where by
individuals and firms take these decisions
without government intervention.
KEY TERMS
Middle-income economies: Economies
where income per head was between $1026
and $3995 (lower middle-income economies)
and $3996 and $12375 (upper middle-income
economies) in 2018 (World bank)
Economic system: The way in which
production is organised and choices are made
in an economy.
Market economy: An economic system
where most decisions are taken through the
market mechanism.
Planned economy: An economic system
where resources are state owned and
allocated by a central body.
Mixed economy: An economic system where
both market forces and government are
involved in resource allocation decisions.
Market mechanism: Resource allocation
decisions are taken by individual producers
and consumers with no government
intervention; also known as price mechanism.

KEY CONCEPT LINK

Scarcity and choice: Scarcity and choice
apply in all economic systems. How choices are
being made in an economic system depends on
 the relative importance of government and
market mechanism.
4.2 The market economy:
Resources are allocated by the forces of demand
and supply through the price mechanism.
Decisions on how resources are allocated are
regularly taken by millions of individuals and
thousands of firms. The government has little or
no direct involvement in the process of resource
allocation. Households and firms interact as
buyers and sellers. Price and the unrestricted
operation of the price mechanism are central to
the way in which resources are allocated.
Firms less willing to supply
How the price mechanism works
Increase in price
Excess supply from firms

More firms now willing to supply

Fall in price

Increase in supply

This shows how the market may operate with no

government interference. The starting point is
that there is excess supply in the market – to
much is being produced compared to demand.
Excess supply results in goods being stockpiled in
shops and warehouses. To encourage individuals
to buy and clear the excess stocks, firms reduce
the price. This may clear the excess supply, but it
is likely to mean that some firms which
previously produced the good will now no longer
be willing to do so. With less supply in the
market, the price rises. In time, assuming no
change in demand, firms may choose to re-enter
the market. The increase in supply will lead to a
fall in price and the whole process will continue.
Therefore, lettuces and self-interest of individuals
and businesses at a guide to the decisions that
have to be made.
Role of the government in a market:
In principle, the government should have no
direct role in the workings of the market
economy and should not interfere with the
operation of the price mechanism. As long as the
price mechanism is working efficiently, the
government’s role is to watch what is happening
and only intervene when the price mechanism
does not provide the best allocation of resources.
When the price mechanism does not work
efficiently, the market ‘fails’. Eg: Governments
provides goods such as healthcare which would
be underprovided, fire services which would not
be provided at all, and where it seeks to regulate
situations to prevent firms using their power to
control the market for excessive gain.
The true market economy is in certain respects
an ideal. No actual economy operates as a pure
market economy.

Government (watches)

Firms Price households

mechanism

4.3 The planned economy:

The planned economy in its true form only exists
in theory. (The planned market economy may be
referred to as a command economy or the
centrally planned economy.)
In a planned economic system, the government
has a central role in all decisions that are made.
The choices in terms of what to produce, how to
produce and for whom to produce are all
centralised. Decision-making is transnational by
planning boards and organisations, in principle,
production is controlled by the state. Unlike the
market economy, the preferences of consumers
and manufacturing organisations in a planned
economy are controlled centrally.
The key features of a planned economy are the
central government and its organisations are
responsible for the allocation of resources.
Production targets are set for the main sectors of
the economy, such as agriculture and
manufacturing. Invariably, these are linked to
planning for long-term growth through an
increase in productive potential. Price control of
most essential items and the determination of
wages are also controlled. Finally, the ownership
of most of the productive resources and
property is in the hands of the state. In short, the
market doesn’t have a real role in the allocation
of resources.
In a planned economy, government
organisations find it necessary, for political as
well as economic reasons, to control the workings
of the market mechanism. Eg: Where basic foods
such as bread and meet are hugely subsided by
the government to keep prices at a low, fixed
level. The rise and fall of prices, so important in
the market economy, does not take place. A
consequence of artificially low prices is often
excess demand relative to supply. There are not
enough basic foods for everyone and queuing
becomes a way of life. Private ownership of
productive resources is restricted to small shops,
restaurants and personal services such as
hairdressing.
Governments of planned economies tend to set
goals which are different from those of
government in market economies. The objective
is to achieve a high rate of growth in order to
catch up on the progress made by the advanced
market economies. Very few planned economies
such as; Cuba and North Korea.
KEY TERM:
Productive resources: Resources that are
available to be used.
4.2 The mixed economy:
The mixed economy is the typical economic
system. In a mixed economy, both the private
sector and public sector have a part to play in
the allocation of resources. Decisions involve an
interaction between firms, labour and the
government mainly through the market
mechanism. There is private ownership of most
productive resources although there is some
public ownership.
Privatisation involves the transfer of resources
from public ownership to private sector. This has
been the case in economies including the
emerging economies of Central and Eastern
Europe and Pakistan.
The increased emphasis on market forces has
resulted in some problems. The UK for example,
has lost many jobs in manufacturing as factories
have closed and production has moved to lower-
cost locations mainly in China, the rest of
Southeast Asia and in Central and Eastern
Europe.
Elsewhere, there have been similar trends. One
of the most dramatic has been in the former
Soviet Union where the economy has been
restructured (perestroika). This has been the
case in its former satellites such as Poland, the
Czech Republic, Slovakia, Hungary, Lithuania and
Estonia. Opening up the economy in this way has
resulted in huge inward flows of foreign
investment, particularly in the manufacturing and
retail sectors. There have been opportunities for
private businesses to be developed – cafés, small
shops and garages as well as the local ownership
of productive resources are now the norm. In
some cases, such as where former state-owned
companies have been sold to the private sector,
the new owners have made vast sums of money
in a very short period of time through adapting
the business to make the most of the
opportunities of the market mechanism. Even in
Albania, once seen as one of the few remaining
planned economies, the government has recently
decided to allow limited privatisation and a
greater emphasis on the market mechanism.
The experience of the Asian Tiger economies
varies, Singapore and Hong Kong, for example,
have always focused strongly on the market to
allocate resources. Their governments have
created an economic situation where free
enterprise is encouraged. The rewards can be
high. Other economies have placed more
emphasis on central planning such as Malaysia,
the Philippines and Indonesia. The extraordinary
continual growth of China over the past 15 years
or so is linked to the controlled management of
the economy but with very clear opportunities for
foreign investors as well as domestic companies
to influence the allocation of resources.
KEY TERMS
Private sector: The part of an economy under
private ownership.
Public sector: That part of the economy under
government ownership.
Privatisation: Where there is a change in
ownership from the public to the private sector.
Emerging economy: One that is making quick
progress towards becoming a high-income
economy.
Asian Tiger economy: Export-led, high growth
economies in Asia.
 Broad explanation of where selected economies
fall in terms of the relative strengths of the
market and planned systems of resource
allocation. To clearly varying degrees, all
countries would seem to fit within the definition
Former Soviet UK Singapore USA
of a mixed [Link] before
1986

North
Korea Albania
Hungary Pakistan France

Planned economy Market economy

Market as a means of
Weak allocating resources
strong

Government control over

Strong the allocation of resources
weak