TYPES OF ECONOMIC SYSTEMS
Core Economic Questions
The fundamental question in the social science of economics is that
of how people can manage to both obtain the things they need to
survive (like food, water, clothing, and shelter) and the things they
want to make their lives easier or more enjoyable (like cars, nicer
homes, luxury items, etc.), when the world has a limited supply of
resources?
A society never has enough goods and resources to meet all of its
wants and needs, and therefore decisions must be made about how to
distribute a society’s limited resources. A society must ask what
goods and services are to be produced. Should a society continue to
build cars which run on gasoline, or should it attempt to build cars
which run on cheaper and cleaner sources of energy? A society must
also consider how the goods and services are going to be produced.
Should societies continue to rely on oil and gas to power machinery,
or should it use another source of power such as nuclear or solar
power? Additionally, a society must ask for whom the goods and
services are being produced. For example, will the goods and
services a society produces only be available to certain members,
such as its wealthiest members, or will they be available to all of its
citizens?
To answer the questions above, societies have developed different
economic systems. An economic system is an organized system
developed by a society or people which governs how it produces and
distributes its resources. Throughout history, societies have
developed four different economic systems to answer the three core
economic questions: traditional economies, command economies,
market economies, and mixed economies. A new form, transitional
economies, should also be included in the list, but will be discussed
later. Each system has its own unique characteristics as well as
strengths and weaknesses when it comes to answering the three core
economic questions.
Traditional Economies
The earliest economic system developed by human beings was the
traditional economy. In a traditional economy, a society relies on
long established customs to determine how to use and distribute its
resources (a custom is an accepted social practice that is handed
down from one generation to the next). Throughout history,
traditional economies have extended to exist in less developed
societies that have primarily relied on hunting and gathering for
survival. The basic unit of economic organization is the family or
extended family. Roles in a traditional economy are passed down
from fathers to sons or mothers to daughters. People tend to accept
these roles without question. Distribution of the resources obtained
by members of the society is determined by long established cultural
practices. For example, there may be a long established custom that
all resources obtained by hunting be shared with all members of a
society.
The primary strengths of a traditional economy are stability and a
strong sense of belonging. Since the roles and rules are passed down
from generation to generation, there is little uncertainty (for example,
no concern over unemployment) and the sense of belonging is strong
because people work together in smaller, closer knit groups to meet
their needs. Traditional economies, however, do have weaknesses.
They tend to be resistant to change and to innovation (like new
technologies), provide few means to deal with emergencies that may
arise (such as natural disasters), and they do not offer a great variety
of resources to their society’s members. Today traditional economies
have largely been replaced by the more advanced economies
described below, but still exist in some indigenous (native)
populations in Africa and Asia.
Command Economies
A more advanced type of economy that replaced traditional
economies in some parts of the world is known as a command
economy. In a command economy, a central government or some
sort of central authority determines how a society will produce and
distribute its resources. In a command economy, the government
makes all economic decisions and owns and operates all the
factories, land, and resources used to produce goods. When a
government owns and operates industries and resources, this is
known as public ownership. Individual citizens have no real say in
what to produce, how to produce it, and for whom the goods will be
produced.
is no competition among different companies which produce similar
goods, there is no guarantee that goods of high quality will be
produced. Since all citizens are guaranteed employment and workers
are generally paid the same regardless of their skills or training, there
is little incentive for people to work hard or to develop new and more
efficient ways to produce goods. The reliance on central planning has
other drawbacks as well: relying on government officials tends to be
costly and inefficient, since government officials (rather than the
people) make decisions about what to produce, the goods the people
really need are often in short supply.
Example: the former Soviet Union.
Market Economies
In a command economy, government officials collect information
about the economy and society and make decisions about the
production and distribution of goods. Government officials tell
individual industries what goods to produce, how to produce them,
how much to pay their workers, and how much they should charge
for their goods. The government or central planning authority will
often set a quota (target each month) of certain goods to be made,
and will tell the industries to which segment of the population the
goods are to be distributed and at what price.
Command economies do possess a number of strengths in
comparison with other types of economies. First, command
economies can help to quickly organize a massive shift of a society’s
resources. For example, a central government authority can oversee
the transition of an economy from less efficient means of production
to the use of modern, more efficient, machinery. Second, command
economies generally provide full employment for their citizens (all
are generally guaranteed a job in one of the state-owned industries)
and services such as health care are generally available.
While the strengths of a command economy may look good on
paper, command economies do have serious weaknesses. Since there
A market economy is the complete opposite of a command economy.
In a market economy it is the people who answer the core economic
questions without interference form the government. A market
economy is an economic system in which private citizens own and
operate factories and businesses and in which prices and production
are determined by the laws of supply and demand (a market economy
is also referred to as capitalism or a free enterprise system). Since the
government keeps its “hands off” the economy and there is private
ownership of property (individual citizens, not the government, owns
property and industries), it is often described by the French term
“laissez-faire” which means “let them do as they please”.
The theory of a market economy was developed by a British social
scientist named Adam Smith. Smith explained the principles of
capitalism in a book known as The Wealth of Nations. He believed
that people should be free to pursue their own self-interests free from
government regulation and interference. There was no need for the
government to regulate the economy because the economy would
regulate itself. For example, businesses compete with one another to
provide the highest quality goods, while consumers attempt to find
the highest quality good for the lowest price. The combination of
competition and pursuit of self-interest, Smith believed, would help
to answer the core economic questions of what goods to produce,
how to produce them, and at what price they will be sold.
Market economies possess a number of strengths which benefit their
citizens. People possess a good deal of freedom in a market
economy, and since the wants of the people determine what is to be
produced there are typically no shortages of the things people want
and need. Competition also tends to have a positive effect on the
quality of goods and on worker initiative. Businesses have a strong
incentive to provide quality goods at a low price (if not they will be
driven out of business), and workers have an incentive to work hard
(they may find themselves unemployed if they do not) and to acquire
additional training and skills (workers tend to earn higher salaries in
market economies based on their unique skills).
While the strengths of a market economy are numerous, market
economies do have a number of weaknesses as well. The pursuit of
self-interest and the need for competition – which together are the
life and blood of a market economy – also create a great deal of
uncertainty. Workers face a great deal of uncertainty and potential
for unemployment, since at any time their job could be shifted to
another country (where wages may be lower) or may be replaced by
a machine (which can do the work more quickly and efficiently) in
an attempt to minimize production costs. Businesses, too, may be
replaced by other businesses which produce a good in a more
efficient manner, resulting in unemployment or creating the need to
learn new job skills and to pursue a different career. Market
economies may also do little to help citizens who cannot help
themselves.
In reality, no true market economy currently exists in the world.
Wheel the United States is referred to as the great “capitalist” nation
of the world. The government does not remain uninvolved in
economic matters. The United States is more accurately described as
a mixed economy.
Mixed Economies
A mixed economy attempts to strike a balance between the strengths
and weaknesses of both a command and market economy. A mixed
economy is an economic system which combines elements of both
command and market economies: businesses are privately owned and
prices are largely determined by the laws of supply and demand, but
the government at times regulates the economy in a number of ways.
Typically, the economic functions of government in a mixed
economy include protecting legal rights, maintaining competition,
providing goods and services, redistributing income, and promoting
economic stability. In general, the government performs the above
functions in an attempt to protect the common good.
Mixed economies attempt to capture both the strengths and
weaknesses of market and command economies. For example, they
attempt to correct the extreme imbalance between rich and poor that
often exists in pure market economies and to provide for citizens
who cannot always provide for themselves. They also try to capture
some of the advantages of a command economy, by trying to aid
those citizens who have lost jobs due to unstable economic
conditions or by providing economic aid to citizens who cannot
afford services such as health care.
Yet, some critics argue that government regulation is still a weakness
in a mixed economy. They argue that some government regulations
(such as environmental protection standards) cut into business
owners’ profits and make businesses less efficient. They also argue
that governments are less efficient than private industries in the
production of goods and services. No system is perfect, but a mixed
economy attempts to capture the benefits of the major types of
economic systems.
Source: Medina City School District, Medina, Ohio