Economic Systems

An Economic System Is the institutional means through which natural resources are used to satisfy human wants.

Economic systems must answer the following questions What goods are to be produced? How are these to be produced? Who is to benefit from the production?

The three economic systems are: Free Enterprise/Market Economy (Laissez Faire or Capitalism) Centrally Planned (Command) Economy Mixed Economy

Free Enterprise Economy This system is based on the theory advocated by Adam Smith. He believed that an economy develops better when individuals are allowed to pursue their own interests. Under this system the gov plays no role in purely economic activities.

Free Enterprise Economy (Capitalism USA) 1. Market Mechanism: Resources are allocated through the market/price mechanism. If there is a sufficient demand for a product/service it will be supplied. The higher the profit the more of a good/service will be produced.

2. Factors of Production: Nearly all of the factors of production are privately owned.

3. Limited government interference: The government exists only to: Supply public goods eg. schools….. Provide a legal framework for citizens Prevent the creation of monopolies

4. Decentralised decision making: Decisions about: allocation of resources what to produce and who gets what are made by individuals/entrepreneurs.

5. Motivated by self-interest: Consumers want to maximise their utility (satisfaction). Producers want to maximise their profits. Investors want to maximise their return.

Advantages 1. Choice: Consumers with income have a wide choice of goods & services. 2. Effeciency: There is an incentive to be efficient as those who are not will go out of business.

3. Innovation: Producers who come up with new ideas will be rewarded by increased sales & profits. 4. Less bureaucracy: As decisions are made by individuals there is less need for large expensive administration.

Disadvantages 1. Unequal distribution of income & wealth: Individuals who cannot supply a factor of production have no wealth. 2. Lack of essential public services: If an activity does not make a profit then it may not be provided. Eg. education.

3. Social costs: Lack of gevernment regulation leads to: Exploitation of labour Pollution Distruction of the environment

4. Vital services in private hands: It may not be desirable to have defence, judiciary, police under private control. 5. Unemployment: Entrepreneurs try to keep costs down….

Centrally Planned Economy (Communism former USSR, China) This system was advocated by Karl Marx & Vladimir Lenin. They asserted that government control of all areas of economic activity is essential in order to eliminate inequalities.

1. Planning Mechanism: Resources are allocated by the state through a planning mechanism. Planners try to predict consumers needs. They fix the price & quantities produced.

2. Factors of Production: The factors of production are owned by the state. Except for labour but this is directed by the state.

3. Maximum government interference: The government exists to regulate all economic activity. 4. Centralised decision making: All decisions are made by the government.

5. Motivated by the common good: Consumers, workers & government are assumed to be selfless. They co-operate together for the common good.

Advantages

Disadvantages