Economic

Systems
 Coping with scarcity
• The world’s resources are limited, but human
wants and needs are unlimited.
• Therefore scarcity exists.
• Scarcity is the basic economic problem; because
scarcity exists, resources have to be allocated.
• The problem of resource allocation, is choosing
what to produce and how much land, labour
capital is needed to produce these things.
• To the economist, all goods and services that
have a price are considered to be scarce relative
to people’s demand for them.
 What, how, and for whom to
produce?
• We have already seen that resources are scarce
and wants are infinite, which leads to choices to
be made.
• These choices are often expressed in terms of
three questions and represents the basic
economic problem
1. What should be produced (and in what
quantities)?
2. How should things be produced?
3. Who should things be produced for?
What to produce?
• What should be produced and in what
quantities?
• One problem facing people when there is scarcity
is deciding exactly what goods and services to
make.
• This involves choosing which wants to satisfy.
Every society, no matter what its size, is faced
with the same choice.
• For example, how many computers to be
produced, how many bicycles, how much wheat,
and how much milk?
• This has to be decided for all economic goods.
How to produce?
• How should things be produced?
• Once it has been decided exactly what goods
and services to produce there is problem of
deciding how to make them.
• There are many different ways to produce
things and there are different combinations of
resources that may be used in production.
• For example: should sports shoes be produced
by an automated production line or by manual
workers? Should crops be grown with high
usage of fertilizer or organically?
For whom to produce?
• Who should things be produced for?
• Should they go to those who can afford them or
shared out in some ‘fair’ manner?
• How will the total income (national income) of
the economy be distributed?
• Will teachers gets higher income then nurses?
• The question of who should get the goods and
services must be answered by society as a whole.
• Economist cannot tell us what is best simply
because the answer depends on people’s
opinions.
• That is, it involves making a value judgment.
Providing answers to what, how, and
for whom to produce
• There are many different answers to these three
questions.
• Every society or country must choose and develop its
own way of solving these problems.
• How a country decides what to produce, how to
produce and for whom to produce is called its
economic system.
• There are two theoretical allocation (rationing)
systems,
➢ The free market
➢ The planned economy.
• In reality all economies are mixed economies, which
are a combination of the free market and planning.
 The market economic system
• A market is a situation where potential buyers
are in contact with potential seller.
• It enables the needs and wants of both parties
to be fulfilled whist establishing a price and
allowing an exchange to take place.
• Markets may be local, national or
international.
• Market can also be divided into product
market (goods and services) or factor market
(factors of production).
• In a market economic system, producers and
consumers decide what, how and for whom to
produce through their exchange or trade in
different goods and services.
• That is, market determine what, how and for
whom goods and services are produced.
• All the resources in a market economy are
privately owned by people and firms.
• Every business will aim to make as much profit
as possible.
• Profit= Revenue - Cost
• All firms aim to make a profit and they do this
by producing only those goods which the
consumers want.
• Firms will produce goods in the cheapest
possible way so as to make the most profit.
• The people who are able to enjoy the goods
and services produced, however, are only
those with enough money to buy them.
• In a market economy high prices are the signal
telling firms what people want, that is what
will make the most profit.
• This is signaling function.
• In the same manner, if the price of a product
was to fall because people are simply not
buying it anymore, this will act as a signal, to
tell firms to move their resources into the
production of something more profitable.
• This is known as price mechanism.
• In this way market forces solve the problem of
what, how and for whom to produce.
Advantages of the market system
1. The market produces a wide variety of goods
and services to meet consumers’ wants
2. The free market responds quickly to people’s
want.
3. The market system encourages the use of
new and better methods and machines to
produce goods and services.
 Disadvantages of the market system
1. Factors of production will be employed only
if it is profitable to do so.
2. The free market can fail to provide certain
type of goods and service.
3. The free market may encourage the
consumption of harmful goods.
4. The social effects of production may be
ignored.
5. The market system allocates more goods and
services to those consumers who have more
money than others.
 Planned Economies
• In a planned economy, sometimes called a
centrally planned economy, or a command
economy, decisions as to what to produce, how
to produce, and who to produce for, are made by
a central body, the government.
• All resources are collectively owned.
• Government bodies arrange all production, set
wages and set prices through central planning.
• Decisions are made by the government on behalf
of the people and, in theory, in their best
interests.
• Examples: North Korea, Laos, Cuba.
 Disadvantages of Planned Economy
system
• Total production, investment, trade and consumption,
in even a small economy, are too complicated to plan
efficiently and there will be misallocation of resources,
shortages and surpluses.
• As there is no price system in operation, resources will
not be used efficiently.
• Arbitrary decisions will not be able to make the best
use of resources.
• Incentives tend to be distorted. Workers with
guaranteed employment and managers who gain no
share of profits are difficult to motivate. Output and
/or quality will suffer.
• The dominance of the government may lead
to a loss of personal liberty and freedom of
choice.
• Governments may not share the same aims as
the majority of the population and yet, by
power, may implement plans that are not
popular or are even corrupt.
 The Mixed Economy System
• In reality, all economies are mixed economies.
• What is different is the degree of the mix from country to
country.
• Some countries, such as China, have high levels of
planning and government involvement in the economy.
• Even in the seemingly free economies, such as the USA,
the UK, or even Hong Kong, government intervention is
very much a part of the economic system.
• Government involvement is deemed essential, since
there are some dangers that will exist if the free market
is left to operate without interference.
Why have a mixed Economic system?
• To create employment opportunities.
• To provide public goods (defence, law and order,
and street lighting) and merit goods (education
and health care), government can raise money by
taxing people’s income and spending.
• To stop people consuming harmful goods by
making them illegal or by placing high taxes on
them.
• The government will think about cost to the
environment which private firms ignore.
• To distribute goods and services equally among
the people.
Adam Smith Karl Marx