Economic Systems

Resource allocations

The method of how an economy designates and allocates its scarce resources such as land, labor, capital, and enterprise to productive uses. Resource allocation usually involves asking the 3 economic questions and determines the type of system.

Types of Economies:

Planned/Command Economy:
All decisions are made by the government, as they answer the 3 economic questions, and allocate resources and fix prices, this type of economy’s motive is social welfare than profit. (e.g. North Korea, Cuba, China, Soviet Union)

Market/Capitalist Economy:
All decisions are made by private firms and entrepreneurs, as they answer the 3 economic questions. In this economy, the government has a very limited role and zero interference within the economy thus no taxes and public spending. (e.g. USA, Hong Kong, Singapore)

Mixed Economy:
It has a degree of command and capitalist economy, usually, this is the only type of economy in practical considering the government can’t have full or non-interference within the economy. In a mixed economy, the resources and decisions are split between the private and public sectors. (e.g. Iceland, Slovakia, and Romania, although these countries may be tilted towards one rather than another)

Traditional economy:
An economy where an individual’s profession is determined by its ancestry, the very essence of this system is based on the past and culture. This system is quite rare and will not be studied in class. (e.g. tribal societies)

Planned Economic System:

All decisions are made by the government. They decide what to produce, how to produce, and for whom to produce. All resources are owned and allocated by the government. They also fix the prices. Efficiency may not be the highest priority as profit isn’t a motive – social welfare is. Thus they could use inefficient production methods to produce the goods. Goods will be produced for all people – mainly those with poor incomes. Rich people may demand luxury goods, which the government might not be interested in producing.
(e.g. North Korea)

Advantages of a Planned Economic System:

  • It’s a welfare-motive economy, meaning it only produces necessities (food/water/clothes), public goods, and merit goods.
  • Prices are kept low, so it is affordable for everyone.
  • Low unemployment can exist as the government aims at full employment.
  • Since there is no competition, duplication of products is eliminated.

Disadvantages of a Planned Economic System:

  • Consumer sovereignty is low as the government decides what to produce.
  • Lack of profit motive may lead to firms being inefficient.

Free Market Economic System:

All decisions are made by private individuals that are, there is no government intervention or involvement in resource allocation. (there are virtually no economies in the world that follow this – there is government control everywhere, though the USA does come close). In this system, profit is the main motive. What to produce is solved by producing the most-demanded goods for which people spend a lot, as their only motive is to generate a higher profit. How to produce is solved by using the cheapest yet efficient combination of resources capital or labor in order to maximize profits.

Advantages of a Free Economic System:

  • Poor Quality. Since profit maximization is the biggest motivation for firms, they may try to reduce their costs unethically. 
  • Merit Goods. Goods and services that are not profitable will not be produced or run. 
  • Excessive Power of Firms. 
  • Unemployment and Inequality.

Disadvantages of a Free Economic System:

  • It contributes to political and civil freedom, in theory, since everybody has the right to choose what to produce or consume.
  • It contributes to economic growth and transparency
  • It ensures competitive markets.
  • Consumers’ voices are heard in that their decisions determine what products or services are in demand.
  • Supply and demand create competition, which helps ensure that the best goods or services are provided to consumers at a lower price.

Mixed Economic System:

In a mixed economy, a government can intervene in different markets in an attempt to corrupt the worst market failures. It can provide useful and essential goods and services, it can outlaw the production of harmful goods and dangerous activities and It can employ people in public sector organizations and provide financial support to private sector firms to boost output and employment.

Advantages of a Mixed Economic System:

  • The government can provide public goods, necessities, and merit goods. Private businesses can provide the most demanded goods (luxury goods, superior goods). Thus, everyone is provided for.
  • The government will keep externalities, monopiles, harmful goods in control.
  • The government can provide jobs in the public sector (so there is better job security).
  • The government can also provide financial help to collapsing private organizations, so jobs are kept secure.

Disadvantages of a Mixed Economic System:

  • Government taxes will be imposed, which will raise prices and also reduce work incentives.
  • Government laws and regulations can increase production costs and reduce production.
  • Public sector organizations may still be inefficient and will produce low-quality goods and services.
  • Personal gain of the government.

What are the different sectors within the economy?

Tertiary Sector

Organizations that consist within the tertiary sector are usually involved with the process of distribution of goods and services. For example, a supermarket would be classified as a company within the tertiary sector as they are involved with distributing goods to its customers.

Secondary Sector

Organizations that consist within the secondary sector are usually involved with the production of goods. They take resources from companies within the Primary sector and convert them into different products ready for distribution. For example, a company producing laptops could consist within the Secondary sector as it is manufacturing a product taking natural resources from the Primary sector. 

Primary Sector

Organizations that consist within the Primary sector are usually involved with the extraction of raw materials or natural resources from the Earth. Examples of companies within this sector are companies that are involved with mining, agriculture, and other means to generate natural resources.