Economic Systems

There are a number of ways in which a government can organize its economy and the type of system chosen is critical in shaping environment in which business operates.

An economic system is quite simply the way in which a country uses its available resources (land, workers, natural resources, machinery, etc.) to satisfy the demands of its inhabitants for goods and services.

There are three basic approaches to economic decisions about resource allocation. One is based on tradition – that is, people generally repeat the decisions made at an earlier time or by an earlier generation.

A second is based on command – that is, decisions are made largely by authority. In a command-planned or socialist economy the government owns most resources and decides on the type and quantity of a good to be made. It sets output targets for each district and factory and allocates the necessary resources. Incomes are often more evenly spread out than in other types of economy.

The third is based on market price. A market or capitalist economy is a system of decentralized decision making in which individuals and business firms participate in the market through decisions that are reflected in the supply and demand and forges out of them an interrelated network of market prices that reflect the preferences of all the participants.

Market prices – and changes in them – act as signals to producers, telling them what buyers want. Firms decide the type and quantity of goods to be made in response to consumers. An increase in the price of one good encourages producers to switch resources into the production of that commodity. Consumers decide the type and quantity of goods to be bought. A decrease in the price of one good encourages consumers to switch to buying that commodity. People on high incomes are able to buy more goods and services than are the less well off.

No recent real-world economy is or has been a pure form of a traditional, command or decentralized market economy. Every existing economy uses a different “mix” of mechanisms to respond to the basic economic decisions, and has somewhat different institutions, controlling values, and motivating forces at work that affect the operation of the economy.

In a mixed economy privately owned firms generally produce goods while the government organizes the manufacture of essential goods and services such as education and health care.

Many economic systems underwent fundamental changes during the last decades of the 20^th century. The element of tradition was more evident in the rural areas of the developing countries of Asia and Africa, yet even those rural areas participated in elements of a market economy and/or a command economy.

The element of command economy had been most evident in the former Soviet Union until the country collapsed. China, which describes itself as a command economy, has many elements of traditional and market-price economies. The American economy is a mixed capitalistic economy, in which both government and private decisions are important; it is an economic system in which there is private ownership of capital, freedom of enterprise, competition, and reliance upon markets.

It should be noted that people of all societies, regardless of the type of economic system, engage in certain basic economic activities. These include producing, exchanging, and consuming goods and services, as well as saving and investing so that capital goods and human capital can be accumulated to increase output and productivity.