Section#2

Topic 1: Economic
Systems
W/ Sir Saad

Micro economics Macro economics

The study of the The study of the whole
behaviour and decisions economy. This includes
of households and firms employment, economic
and the performance of output, inflation etc in
individual markets. the country.

Market: An arrangement which brings buyers into

contact with sellers.
Connection between microeconomics and

macroeconomics:
Many concepts of microeconomics are used in
macroeconomics, but on different scale.
• Demand for an individual product, and the total demand for
all goods and services in an economy.
• Why price of a particular product might change and why the
price level in an economy may change.

Micro economic decisions and interactions add up to the

macroeconomic picture.
• A reduction in the output of the textile industry may result
in arise in the countries unemployment rate.
• A decision by the government to cut income tax may result
in households buying more clothing.
Aims of the decision makers:
The decision makers in microeconomics and microeconomics
are sometimes referred to as economic agents.

• Households:
Households are buyers, also known as consumers, savers and

workers.

• Firms:
Firms are business concerns that produce goods and services,
and employee workers and other factors of production.

• Government:
Government is the system which rules a country or region. A
government produces and provides some products, provides
financial benefits, and taxes and regulates the private sector.
Aims of the decision makers:
• Households:
1. As customers, they seek low prices and good quality
products.
2. As workers they want good working conditions and high
pay.
3. As savers they want their money to be safe and to get a

good return.

• Firms:
Firms in the private sector usually try to make as much
profit as possible.

• Government:
1. Government wants a strong economy.
2. For macro economics, they may want full employment
of labour.
3. For microeconomics they may want to influence
individual markets by for example taxing sales of
cigarettes.
The role of markets in allocating
resources:

Three key allocation decisions:

1) What to produce?
This is where the decision makers answer which goods should be
made. For example does the economy need more schools or should
they develop more infrastructure.

2) How to produce?
This is where the decision makers answer what combination of
resources/factors of production to use. The decisions are based on
cost, efficiency and type of product. If labour is more efficient
and cheap decision makers would deploy more labour for
production.

3) For whom to produce?

This is where the decision makers decide which economic agent
receives the goods and services. For example, is it free for
everyone or should it be only given to the people who can pay
healthcare might be free for everyone however private schools

should only be for the people who can pay.

Different economic systems:
An economic system describes the way in which an economy is
organised and run, including alternative views of how
resources are best allocated. There are three main types of
economic systems.
1. Market economy
2. Planned economy
3. Mixed economy

Planned Economic system:

A.K.A centrally planned, command or collectivist economy. It
is an economy in which the state/government makes the
decisions about what to produce, how to produce it and who
receives it. The state owns all, or at least most, of the land and
capital, and it employs workers.
• The state gives instructions, sometimes called directives, to
state owned Enterprises on what to produce and how to produce
it.
• The state determines who gets the products which are made
and it decides on the price to charge.
• The state will usually provide basic necessities and important
products such as housing, transport and education free of
cost or at low prices.
• Wage differentials are minimal due to the aim of equality
and eliminating social gap.

Advantages Disadvantages
• Large potential for economies of • Due to absence of price mechanism
scale By operating large the government is unable to guess
government Monopoly like water exact quantities demanded which
supply, public transport, electricity. can lead to surplus and shortages
EOS is a situation where by in the economy.
increasing the scale of production • There is a lack of variety of goods
average cost per unit decreases. which reduces standard of living.
• Due to absence of competition Since the market lacks competition
wastage can be reduced. Since costs and the government is more focused
of advertisement will be non- on being self-sufficient, it leads to
existent and state will only provide production of necessities not variety
goods that are necessary which will of course.
lead to less wastage of scarce

resource.
• The gap between the rich and the • The economy is less responsive to
poor is minimised. Since the customer needs. Since bureaucrats
government provides basic needs to taking the decision, they take
be met for everyone in the society. entrepreneurial risks and lack
For example, education and innovation.
healthcare for all.
• The government keeps a check on
externalities like pollution and
reduce the production of demerit P S
goods like alcohol, cigarettes etc.

P e

Shop owner
5000 p
nooo
1000 0
500 monk 2000 2000 oty
Market economic system:
A.K.A market economy or a free enterprise economy, Is an
economic system where consumers determine what is produced,
resources are allocated by the price mechanism and land and
capital are privately owned.
• in a market economic system, government intervention is
minimal.
• Private sector firms decide how to produce the products
consumers want to buy.
• Firms can either choose to be capital intensive or labour
intensive.

Capital intensive:
These are the firms which use a high proportion of capital
relative to labour.

Labour intensive:
These are the firms that use a high proportion of labour relative
to capital.
• In making their decision on which factor of production to
employ, firms will seek to achieve the lowest cost method of
production, while producing the highest quality of products.
To achieve this, they might employ new, more productive
capital equipment, to replace old equipment.
• Resources are allocated on the basis of price. Higher the price
more the supply, lower the price more than demand.
• Only those who can pay get resources.
• Production of profitable product products is maximised
where as production of unprofitable products is stopped.
• There is competition in the market which leads to greater
choice for the consumers.
Advantages Disadvantages
• Market economies are efficient and • market economies is create
pay attention to what consumers negative externalities like noise,
want. Due to presence of air and water pollution. In an
competition companies try to create attempt to reduce their private
unique selling points and tend to costs under their profit
develop better technologies and try maximisation motive.
to create innovative products to • Private firms under profit
attract and satisfied their maximisation will produce
customers. demerit goods. Demerit goods are
• There is freedom of choice as bad for society for example,
government intervention as alcohol and cigarettes.
minimised. Individuals can choose • Due to absence of government
to buy whatever they like. This control, public goods such as
provides variety of goods and street lights and roads might not
services. be provided.
• Market economies are driven by the • Due to competition firm tend to
profit motive which motivates waste valuable resources on
businesses and individuals to activities like excessive
work hard. These incentives help advertising. This also leads to
boost the economic growth and consumer exploitation.
raise the standard of living.
• There is no redistributive
mechanism of income. Those who
earned the highest income exercise
the maximum influence on what is
produced. People with skills highest
in demand and the most successful
entrepreneurs will be able to buy
more products than those whose
skills are low in demand and are
unsuccessful entrepreneurs.
Mixed economic system:
A mixed economy is a combination of both market and
planned economy. Main features include:
• The degree of private and public involvement is determined
by the government.
• Essential services like health, education, street lighting,
public transport, defence is provided by the public sector.
The private sector provides goods and services demanded by
the customers like cars, entertainment, tourism etc.
• This is a good system since it strikes a balance between
both the worlds, however it should always be noted that even
in mixed economy consumers sometimes have to pay high
prices if there are private monopoly and public sector is
prune to inefficiency.

Note:
if a question asked for why a mixed economy should be used
we just have to mention the advantages of market economy
and then disadvantages of market economy and suggest why

government intervention is needed.