What are Economic Systems?
As we have learned, economics is a social science concerned mainly with
the production, distribution, and consumption of goods and services. And
economics follows how people make choices on products or services which
they buy based on their trade-offs and opportunity costs. Consumers are
forced to make choices because of scarcity. Scarcity exists because there are
limited resources in the world while consumers have unlimited wants.
Scarcity requires that the three basic economics questions be answers: What
to produce? How to produce? For whom do we produce?
Each economy answers the three basic economic questions differently. The
answers to the questions shape the economic system of each society. So
what are the different types of economic systems? What are the similarities
and differences of these systems? And what are the positive and negative
factors that shape these systems?
Vocabulary:
Term
Definition________________________________
Authoritarian System
a system that requires absolute obedience to the
rulers of a society
Capitalism
an economic system based on private ownership of
the factors of production
Centrally Planned
Economy
a system in which the society’s leaders make all
economic decisions.
Command Economy type of economic system where the government controls all
aspects of the economy
Communism
type of command where there is no private
ownership of property and little to no political
freedoms.
Competition
the effort of two or more people, acting independently, to
get the business of others by offering the best deals
Economic Systems
wants
Market
Market Economy
the way a society uses its resources to satisfy its people’s unlimited
any place or situation in which people buy and sell
goods and services.
economic system which is based on an individual’s choices
Mixed Economy
an economic system that has elements of traditional, command,
and market economies
Private Property
Rights
the rights of individuals and groups to own property
Socialism
type of command economy where government owns some or all of the
factors of production
Specialization a situation in which people concentrate their efforts on the areas in which
they have an advantage
Traditional Economy an economic system where families, clans, or tribes make
economic decisions based on customs and beliefs
The basic questions of production are answered by each society differently
based on the economic systems they have chosen to abide by. An economic
system is the way a society uses its resources to satisfy its people’s
unlimited wants. There are three basic types of economic systems. They are
traditional economies, command economies, and market economies.
The first type of economic system we will discuss is the traditional
economy. A traditional economy is an economic system where families,
clans, or tribes make economic decisions based on customs and beliefs.
These beliefs and customs were handed down from generation to generation.
The goal of these societies is strictly survival. Each person has their own
specific role that they play in the economy. Men hunt, women farm and
cook, etc. If a man’s father was a blacksmith, he will also be a blacksmith,
and his son will be a blacksmith too. The good of the whole society is
always more important than that of the individual members. Therefore, there
are not as many wants in these types of economies. The only concern is for
the basic needs of survival.
The traditional economic system, unfortunately, is pretty inefficient. It relies
on habit. These people are so stuck in their ways that they do not change,
when sometimes change, new ideas, or innovation is a good thing.
New technologies, medicines, ways of production, etc will only help an
economy. But, in traditional economies, these ideas are rejected because of
old habits. So, when an economy resists change, they become less
productive than other economies that use new skills and technologies to
produce. People do not get to choose a job of their liking either. They are
usually stuck doing what their other family members did. Or, they are given
a job based on their gender, not on their skills or interests. When someone is
not happy with their job, they also become less productive because the job
does not fit their abilities or interests.
Societies that use a traditional economy are usually very poor, third world
countries and clans like small tribes in Africa and the Middle East. These are
small community societies that are very close. They lack modern
conveniences like microwaves and even running water. They have a low
standard of living and often struggle just to have enough to eat.
A command economy is another type of economic system where the
government controls all aspects of the economy. It decides what goods and
services will be produced, how they will be produced, and how they will be
distributed. Government officials consider the resources and needs of the
country and put those resources to use accordingly. Wants of the consumers
are not taking into consideration. It is all based on what the government
wants, says, and does. The government also owns all the means of
production, like the factories and machinery. Command economies are
sometimes called a centrally planned economy, or a system in which the
society’s leaders, usually members of the central government, make all
economic decisions.
Many societies have decided to form a command economy. There are
various types of command economies. Socialism is a type of command
economy where government owns some or all of the factors of production.
These ideas were first born from Karl Marx and his ideas about the perfect
society. In his novel, The Communist Manifesto, he describes a society
where everyone had the same needs and wants which were all fulfilled. He
called this society a utopia, or a perfect society but it was imaginary.
Governments decided they can actually create this society and have taken
these ideas to the extreme. They still try and make Marx’s ideas a reality but
it never really works. Communism, another form of a command economy is
the more extreme form of socialism where there is no private ownership of
property and little to no political freedoms. Communism grew after WWII in
countries like the Soviet Union, Cuba, North Korea, and North Vietnam. It is
essentially an authoritarian system, or a system that requires absolute
obedience to the rulers of a society.
Command Economies have good intentions when they are formed. They
want to provide for everyone equally, but everyone’s situations are different
and that means their needs and wants are different. So, the government
cannot please everyone. These economic systems often face shortages of
goods and services. The workers are also assigned jobs which they may not
be good at doing and may dislike. Therefore, their motivation to work, use
of resources wisely, and to do a good job is lacking. Governments in these
types of systems are often violent and the people of the country suffer from
poverty and fear of their rulers.
A market economy is the last type of economic system which is based on
individual choices. This means that consumers and producers make the
economy work. How? Well if a consumer is interested in a certain good,
they will spend their money on that good. This motivates the producers to
choose to produce that good in order to make money. Consumers and
producers balance the economy in this way. This kind of economy is driven
mostly by an individual’s self interests and what they desire based on the
choices they make, not as the society as a whole.
There are 3 important characteristics of a market economy. The first is
private property rights, or the rights of individuals and groups to own
property. This is not limited to just land. Property means everything that a
person owns and every service that a person can provide, like their own
labor on the job. The other important characteristic of a market economy is
the market, which is any place or situation in which people buy and sell
resources and goods and services. Markets can be stores, outlets, fairs, or
even internet stores like Amazon. It is anywhere that people exchange goods
or services. Without a market, consumers cannot get goods and services and
producers cannot make a profit by selling them.
Competition, the effort of two or more people, acting independently, to get
the business of others by offering the best deals, is the last important
characteristic of a market economy. This shows that the consumer holds the
power in the market place as producers compete against each other in their
prices and services to get consumers to buy their products. Consumers who
are pursuing their own interests will buy the lower priced item in a market.
Producers will continue to lower their prices as much as possible to make
people to buy their goods and services rather than their competitor’s goods
and services. Competition is the main regulating force in the free market and
the reason why consumers and producers balance out the economy.
A market economy wants people to use the resources they have efficiently
by allowing people to create businesses that interest them and that they are
good at. This is called specialization, or a situation in which people
concentrate their efforts in the areas in which they have an advantage. If you
are a talented hair dresser, you go into the barbering business and service
consumer’s hair all day because you are good at it and will make a lot of
money. This is because it is easier to learn one new task very well than to
learn everything there is to learn in life to become self sufficient (able to
produce everything someone needs on your own without the need of
purchasing any goods and services ever) from all producers. Specialization
also leads to efficient uses of resources including capital, land, and labor.
But specialization removed the need for households to be self-sufficient.
Markets allow consumers to buy goods and services with money in order to
fulfill their needs and wants, because they cannot fulfill these needs
themselves. If specialization did not exist, and people were self sufficient,
producing everything they want to consume, there would be no need for
markets.
Under the market economy, government has limited involvement. They try
not to interfere with consumers and producers because they already balance
each other in the economy. This idea of limited government involvement in
the economy is sometimes called laissez faire economics. The most
powerful form of market economic systems is in the form of free markets or
capitalism, an economic system based on private ownership of the factors of
production. “Survival of the fittest” is a phrase commonly used in
capitalistic economies because if you do not have enough money to purchase
goods and services, it means you are simply lazy. However, there are no
pure market economies in the world! They all have some form of
government involvement, even in the United States.
That leads us to the idea of a mixed economy which is an economic system
that has elements of traditional, command, and/or market economies – it is
the most common type of economic system. In the United States, we have a
mixed economy. It is mainly a market economy, in the form of capitalism,
but the government must intervene to keep order, provide services like with
the military or health care system, and to make sure the welfare of all is in
order, especially for senior citizens and the disabled. Even though people
have a high level of economic freedoms in the US, the government steps in
to regulate things by creating laws to protect private property, a main
characteristic of a market economy.
So, these are the four main economic systems. One a society has an
economic system established; it is then able to answer the basic economic
questions. These questions are what to produce, how to produce, and for
whom to produce?
The following image may help you understand a few different
types of economic systems. Please note, this is not ALL of the
economic systems. This table shows two versions of the command
economy, communism and socialism, and the market economy.
The traditional economic system is not shown on the chart.
Communism
Socialism
Market System
Who owns
resources?
Government owns
everything
All resources are
privately owned
Who decides
how resources
will be used?
What is the role
of the
government?
Government officials
decide
Government owns
basic resources and
the rest is privately
owned
Government planners
and market forces
share the decisions
Government makes all Government makes
economic decisions
decisions in only the
basic industries
Market forces decide
Governments role is
limited—mostly to
ensure forces are free
to work
Questions:
1. Which of the basic economic systems allow government to control most aspects of the
economy?
A. mixed economy
B. command economy
C. market economy
D. traditional economy
2. What would result if everyone became self-sufficient?
A. a command economy would form
B. government would take over
C. specialization would increase
D. there would be no need for markets to purchase goods and services
3. What is a characteristic of a market economy?
A. markets
B. private property
C. competition
D. all of the above
4. What assumption can we make about people living in command economies?
A. they are happy with their government
B. they have all their wants and needs met
C. they are experiencing shortages
D. they are all happy with their jobs
5. What influence does the government have in a market economy?
A. they have limited control of the aspects of the economy
B. they have no control of any aspects of the economy
C. they are forced to keep out of economic affairs
D. both B and C
6. What is the best definition of a mixed economy?
A. the least popular type of economic system
B. an economy that has all three of the other economic systems present
C. an economic system that has elements of traditional, command, and/or market
economies
D. none of the above
7. The main concern of a traditional economic system is …..
A. to be the most productive society globally
B. to make private property and competition laws
C. to support the wants and needs of the individual consumer
D. to support the basic needs of the society as a whole
8. Once an economic system is established, what can/cannot be done?
A. the basic economic questions can be answered
B. resources can no longer be produced
C. government can take over the society’s economy
D. laissez faire economics can begin
9. Based on the information you read from this lesson, do you think that when people are
assigned a job, it is the best thing for the economy?
A. yes, because they can now get to work and produce goods
B. no, because if it is not a job they are good at or like, they will be less motivated
C. no, because if it is not a job they are good at or like, they will be less productive
D. both B and C
10. What are some negative effects of the traditional economy?
A. they are always choosing new ideas and technologies
B. they are inefficient in providing goods and services to the society
C. they assign jobs based on test scores
D. all of the above
11. How is communism different than socialism?
A. government in communism own all aspects of production and governments in
socialism own only some
B. government in socialism own all aspects of production and governments in
communism own only some
C. government does not own any aspects of production in socialism and owns all of them
in communism
D. government in communism own all aspects of production and markets own all aspects
in socialism
12. What is a common phrase used in capitalism?
A. freedom of the market
B. there’s nothing better than money
C. survival of the fittest
D. taxation without representation
13. In a short paragraph, define the term economic systems. Then give two examples of
different types of economic systems. Then, give at least 2 similarities and/or differences
between the economic systems you chose.
An economic system is the way a society uses its resources to satisfy its people’s unlimited wants. There are three
basic types of economic systems. They are traditional economies, command economies, and market economies.
14. In a short paragraph, choose which economic system you think is the most effective.
Give the definition of the economic system you chose. Be sure to give specific examples
of why they economy is efficient to support your answer.