Nowadays, there are three main economic systems, or the ways a government can organize its economy: Free Market Economies, Command (Planned) Economies and Mixed Economies.
The way a government organizes its economy will have an impact upon all other economic agents within the borders controlled by that government.
1. Free Market Economies
Individuals make decisions about what is produced, but the government influences these decisions through law and legislation. Consumers, producers, Private Property Owners (PPO), and the government are the economic agents involved.
Individuals and organizations are motivated by profit and self interest. Consumers want a better life and producers and Private Property Owners (PPOs) want to maximize profits. The government is the ‘guardian’ of the system and should create fairness and promote welfare.
The characteristics of the economy are:
- Private enterprise – Individuals may set up businesses.
- Private ownership – Individuals can own resources such as land and capital and make decisions about what type of work they do.
- Competition – Different businesses fighting for consumers’ spending and loyalty leads to an efficient allocation of resources.
- Decentralized decision making – Individuals and private firms make decisions about what to produce, how it is produced and for whom.
- Consumer sovereignty – The power consumers have in directing market economies because goods and services are produced and exchanged mostly to satisfy consumer needs and wants.
- Quality and Innovation – Profit motive means that companies strive to be superior to competitors leading to the invention of new products and services.
- Distribution and wealth – Although income distribution may be unfair in a market economy, the profit motive encourages all to participate.
- Efficiency – Producers produce based on what people want and consumers use their own resources to get what they want leading to an efficient allocation of resources.
Answers the economic questions:
- WHAT? Customers cast their ‘dollar vote’ (produce what people will pay for).
- HOW? Producers use the lowest cost method.
- FOR WHOM? Those with the highest incomes. The level of income is determined by the value of the resources we have to sell.
2. Command (Planned) Economies
All decisions are made by the government; this is called ‘central planning’. The government, consumers, and workers are the economic agents involved. None of these groups are motivated by profit. Instead they work for society and the common good. In order to achieve these goals everything is owned by the state (public ownership). The government plans resource allocation, who can decide what a factory makes and even what job a person does. Essentially, consumption is controlled.
The characteristics of this type of economy are:
- Inefficiency – Providing for needs may mean employing more labor than necessary or neglecting projects that would be very profitable for the few.
- No or little choice – Production is based on needs, not wants. Therefore consumers don’t have the choice seen in market systems.
- Beneficial for society – If the needs of all are catered for.
- Equality – A command economy should not have the problems associated with a wealth gap (the division between the rich and the poor).
- No competition – The government is the only provider.
Answers the economic questions:
- WHAT? Decided by central planners/committees, representing the state. Targets specific work units.
- HOW? Specified by central planners. May vary according to a political agenda – not necessarily the cheapest method, e.g. if low unemployment is a goal, the government may want to use a labor intensive method.
- FOR WHOM? Production is for the benefit of all and the greater good.
3. Mixed Economies
In reality all economies are mixed. We use the term command economy or market economy, if an economy strongly shows the characteristics of each economy.
A market economy will still have a government that implements law. To maintain the law the government pays for police, the armed forces and contributes to schools and health care. A command economy still pays its workers wages (although their choice of goods will be limited).
Command economies also have ‘black markets’, which inspire the type of profit motive associated with market economies. Black markets are markets in which products are bought and sold illegally.
