CHAPTER 2: ECONOMIC SYSTEMS
Learning Outcomes:
This chapter uses the three central economic questions – what, how, and for whom – to introduce a number
of concepts, economic systems and ideas of famous economists. A mastery of this chapter should enable
students to:

Name the three central economic questions;

Discuss the differences between the major economic systems (i.e. traditional, command, market and
mixed);

Describe the salient features of the market economy;

Briefly describe the major contributions of Adam Smith, Karl Marx and John Maynard Keynes; and

Understand and / or define the important concepts listed at the end of the chapter.
Written assignment questions / Tutorial questions / Self-study questions:
1
What are the THREE central economic questions that all economic systems must answer (p. 26)?
(3)
Note:
All societies, past and present, have had to seek answers to the fundamental questions of what to produce,
how to produce and for whom to produce. The first two questions deal with the issue of production and
allocation, whereas the last one deals with the issue of distribution. For this purpose each society adopted
an economic system that represented a method of allocating their productive resources to provide for the
wants and needs of its citizens / consumers, thus dealing with the aforementioned fundamental questions.
Generally, every economic system can be classified as a traditional, command or market economy, even
though most are a combination of the three.
The following questions can be asked in order to categorise countries into the different market systems:

Who are the owners of the factors of production? (I.e. to whom are property rights assigned?); and

Do economic decisions occur in a centralised or decentralised manner? (I.e. what coordinating
mechanism is in place to coordinate the economic activities of the participants in the economy?) (Mohr
et al. 2015:27).
2
Explain and clearly differentiate among the following economic systems by referring to property rights
and the coordinating mechanism:
a)
b)
c)
d)
the traditional system (p. 26);
the command system (pp. 27 – 29);
the market system (pp. 29 – 31 and pp. 28 – 29); and
the mixed economy (pp. 32 – 34 and pp. 28 – 29).
Note: The table below offers a solution to Question 2.
Traditional
Command
Property
In this type of The
socialist
Rights
economic
system command system is
the ownership of the characterised
not
factors of production only
by
central
and
decision- planning, but also by
making
are state ownership of all
determined
by goods, services and
tradition. Examples factors of production
include
the (except labour). In a
traditional
chief communist
owning
all
the command system
factors
of all resources are,
production, and the however, owned by
San people, for everybody.
whom the concept
of private ownership
of land is unknown.
(4 X 2 = 8)
Market System
The market system
is characterised by
the
private
ownership of the
factors
of
production.
Mixed Economy
In a mixed economy,
some enterprises, or
significant shares in
them,
are
owned
directly or indirectly by
the state. Most factors
of
production
are,
however,
privately
owned.
Coordinating
mechanism
Decisions
about
what, how and for
whom to produce
are made according
to
tradition.
Whenever
a
decision has to be
made, people want
to know what the
society has always
done
in
this
situation.
In the command
system
the
participants
are
instructed what to
produce and how to
produce it by a
central
authority,
which
also
determines how the
output is distributed.
In
a
market
economy
coordination
is
achieved
through
the
market
mechanism or price
system, i.e. through
the
free
and
spontaneous
movement of market
prices,
as
determined by the
operation of the
forces of demand
and supply.
Economic
decisions
are
made
partly
through the market
and partly by the
government.
The
degree of the mix
varies from country to
country. The market
mechanism
(prices)
determines the type
and
amount
of
production that will
occur.
The
government plays a
role in the provision of
social services, e.g.
building
low-cost
housing.
3
Define a “market” and then name the FIVE conditions that have to be met in order for a market to exist
(p. 28).
(6)
4
Name and explain the TWO important functions that prices serve in a market economy (p. 32). (2 X 2 = 4)
5
Differentiate between privatisation and nationalisation (p. 33).
6
Briefly describe the major contributions of the following gentlemen behind the different economic
systems:
a)
b)
c)
Adam Smith (pp. 34 – 36);
Karl Marx (pp. 36 – 37); and
John Maynard Keynes (pp. 37 – 38).
(2)
(3 X 3 = 9)
Note: The table below offers a solution to Question 6.
Adam Smith  Emphasised the importance of three interrelated things as sources of wealth: the
division of labour, free trade and a limited role for government.
 He argued that individuals should be allowed to pursue their own self-interest
 and that the market would then act as an invisible hand to ensure that their decisions
would promote national interest.
Karl Marx
 Argued that labour was the source of all wealth in economies.
 However, he believed that labour was exploited by the capitalists as workers’
contributions exceed the amount they receive in wages.
 Marx further argued that capitalism will lead to its own destruction and that through a
revolt capitalism would be replaced by a classless system.
John
 Believed that markets should be allowed to function freely without government
Maynard
intervention.
Keynes
 However, in the event that markets do not clear because of insufficient aggregate (total)
demand for goods and services, then it was the duty of government to step in to
stimulate the demand for goods and services by applying expansionary fiscal policy
measures.
 These measures included increasing government spending or decreasing taxes.
For your information:
In his book, The Wealth of Nations, Adam Smith wrote that a participant in a competitive market is “led by an
invisible hand to promote an end which was no part of his intention.” As such, when economists refer to
“the invisible hand,” they mean that market participants act in their own self-interest, attempting to
maximise their own well being, and the result is an efficient use of resources. This result occurs because the
market forces of supply and demand invisibly guide resources to their highest valued uses.
Revision:
Indicate whether each of the following statements is True (T) or False (F).
True
(T)
1
2
3
4
5
6
7
8
9
10
11
The three central questions in Economics are What? How? and For Whom?
Economic systems are based on any or a combination of three coordinating
mechanisms: tradition, command and the market.
The chief characteristic of the market economic system is that the state plays an
important role in deciding how the basic economic questions are to be answered.
If in an economy there is a need for more workers but women are prevented from
working by religious doctrine, then this part of the economic system most closely
resembles a traditional economy.
In pure capitalism, property resources are publicly (state) owned.
Privatisation refers to the transfer of assets or different forms of economic activity from
the public to the private sector.
One of the conditions for a market to exist is that the agreement must be guaranteed by
law or tradition.
The allocative function of prices implies that prices act as signals to allocate production
factors between different uses in the economy.
Adam Smith's invisible hand principle stresses the tendency of self-interested individuals
to pursue activities that benefit themselves, but harm the overall economic welfare of
society.
In Marx’s opinion capitalists were the oppressed and the workers were the oppressors.
Someday, Marx predicted, the workers would rise up in a revolution against a system
benefiting only the owners of capital.
John Maynard Keynes’ solution to the central problem of the Great Depression of the
1920s and 1930s was to urge governments to stimulate the economy by undertaking
public works projects to provide jobs and by lowering taxes.
False
(F)