Chapter 2

2.1 Economic systems

Introduction

An economic system is a pattern of organisation which are aimed at solving the three
economic questions namely, what shall be produce, how will the goods and services be
produce and who (for whom) will receive the goods and services produced.

What to produce

What goods and services shall be produced? What output shall we see in the shops we
visit? The goods and services we as consumers demand. Thus consumers indicate to the
firms what to produce by buying the goods. If goods are produced that is not sold, the firm
will remove them from the shop and stop the production. So who decides what to produce?
Consumers

We note here that if a person has no money he/she cannot vote (through buying) for any
good or service to be production. Only those who have money, for them will be produced

How will the goods and services be produced

The entrepreneur will combine the resources in such a way that he/she can make a profit
on sales. If no profits, no production. The entrepreneur must thus aim to operate efficiently
when he/she uses the scarce resources keeping the cost low, making the maximum profit
while competing with other firms.

For whom: Who will receive the goods and services that were produce?

Who will get the goods in the shops, who will receive the many services produced in our
economy and where will the production occurs.

It is obvious that the produce will be allocated to those with an income (money to
spend). The community member must therefore have a job from where the income is
generated or receive a grant from Government to be able to receive some of the produce.

In short we can conclude that the distribution of the goods and services goes to those who
participated in the production thereof. The participation in the production process
generates an income and the income is used to obtain the goods and services the
consumer demands.

Classifying economic systems (Box 2.1 on page 27)

We have two basic criteria namely property rights and the coordinating mechanism for
the classification of economic systems

Property rights refer to who owns the resources like the factories, mines, airways banks
universities called productive assets. Do the individual in the community have the right to
own property, use it for own interest and or may he/she dispose of it (sell the property) for
own interest. Property can be owned privately or publicly.

Coordinating mechanism is a means of providing and transmitting information so as to

coordinate economic activities of the many participants in the economy.

The market economy uses prices to communicate to the participants. We decide to apply for
a job because we want the income. The higher the income the more students would like to
apply for the job. We want to buy goods, and we check prices. The lower the price , the more
we will buy. The price mechanism is the mechanism for communication in a market
economy.

In the central planned economy the Government makes has a central plan of how the goods
should be distributed.

2.2 to 2.5 The 4 Types of Economic Systems Explained

[Link]

14TH MAY 2014 BY WILL GEMMA

There are four primary types of economic systems in the world: traditional, command,
market and mixed. Each economy has its strengths and weaknesses, its sub-economies and
tendencies, and, of course, a troubled history.

Below we examine each system in turn and give ample attention to the attributes listed
above. It’s important to understand how different parts of the world function economically, as
the economy is one of the strongest forces when it comes to balancing political power,
instigating war and delivering a high (or low) quality of life to the people it serves.
1. Traditional Economic System

A traditional economic system is the best place to start because it is, quite literally, the most
traditional and ancient type of economy in the world. There are certain elements of a
traditional economy that those in more advanced economies, such as Mixed, would like to
see return to prominence.

Traditional economies still produce products and services that are a direct result of their
beliefs, customs, traditions, religions, etc. Vast portions of the world still function under a
traditional economic system. These areas tend to be rural, second- or third-world, and
closely tied to the land, usually through farming. However, there is an increasingly small
population of nomadic peoples, and while their economies are certainly traditional, they often
interact with other economies in order to sell, trade, barter, etc. Traditional systems tend to
be subsistence economies

The traditional system provides clear and easy answers to the three central questions of
what-, how-, and for whom to produce. The production and distribution is done the same
way as each successive generation.

Advantages: One of the most obvious advantages is that tradition and custom is preserved
while it is virtually non existing in market/mixed economies. There is also the fact that each
member of a traditional economy has a more specific and pronounced role, and these
societies are often very close-knit and socially satisfied.

The main disadvantage is that the traditional economy is a rigid system which is slow to
adapt to change. Economic activity is usually secondary to tradition (cultural) and religious
values. A lack of economic development for a growing community is present: medicine,
centralized utilities, technology, etc.

2. Command Economic System

In terms of economic advancement, the command economic system is the next step up from
a traditional economy. This by no means indicates that it is fairer or an exact improvement;
there are many things fundamentally wrong with a command economy.

Centralized Control: The most notable feature of a command economy is that a large part of
the economic system is controlled by a centralized power; often, a federal government. The
government then steps in and regulates the resource(s). Often the government will own
everything involved in the industrial process, from the equipment to the facilities.(factors of
production are owned by the government)

The three economic questions, what-, how-, and for whom to produce is decided by
government with the aid of a central plan

Central planning is a massive task as the planners have to determine what consumer goods
should be produced, how to produce them and then how to distribute the produce. It is
further complicated when deciding on how many resources should be allocated for the
production of capital goods and how many for the production of consumer goods.

In the 1970s and early 80s more than a third of the world’s population lived in countries who
adopted the centrally planned economic system. (Russia, China, Poland, Romania, East
Germany and North Korea) Currently North Korea is regarded as the best remaining country
of which the economy is based upon central planning.

Advantages: As long as the government uses intelligent regulations, a command economy is

capable of creating a healthy supply of its own resources and it generally rewards its own
people with affordable prices (but because it is ultimately regulated by the government, it is
ultimately priced by the government). There is often no shortage of jobs as the government
functions similarly to a market economy in that it wants to grow and grow upon its populace.

Disadvantages: This kind of economy would, over time, create unrest among the general
population. Governments are generally inefficient in production and many resources are
wasted.

The disadvantage of a communist system is that it relies upon everyone in the system being
altruistic. It does not take into account that people tend to be selfish, and do what is in their
personal best interests.

Another fault of the communist system is that it relies on centralized planners to send
manufacturing signals. Any centralized planning system cannot respond to changes in
demand as rapidly as needed, and so some goods are overproduced, while others are under
produced. And due to the lack of individual incentive to produce, there is less in the
aggregate for everyone.
Because all decisions are made by a central body, much complexity and inefficiency is
involved. There is also inefficient allocation of resources because prices are artificial, there is
no signal to producers and consumers to produce and consume so that there is economic
efficiency.

State own firms have less incentive to increase efficiency. Workers have little incentive for
hard work, resulting in decrease in productivity. There is also failure of quality control
resulting in poorer quality goods, as well as destruction of the environment as firms only aim
to meet their target for production without taking the pollution they produce into
consideration.

3. Market Economic System

A market refers to any contract or communication between potential buyers and potential
sellers. No fixed location is required (internet buying and selling) for a market to exist.

For a market to exist, the following conditions must have been met:

There must be one seller and one buyer, the seller must have something to sell, the
buyer must have the means to pay, a market price must be established and the
agreement must be guaranteed by law.

Market systems are often called “capitalist” systems. Capitalism refers to a particular type of
ownership of the factors of production. Whereas most of the factors of production in a
socialist state are owned by the state, a capitalist system is characterized by private
ownership (individuals may own factors of production). Markets can be used in a socialist
system called market socialism.

Market capitalism is characterized by individualism, private freedom, private ownership of

property, property rights decentralized decision making and limited government intervention
(text book page 29)

In capitalism economic activity is driven by self-interest (people respond to monetary

incentives) and competition. Workers want the highest possible pay while firms want the
highest possible profits. In the market economy these two groups come together and
negotiate a settlement that makes both groups satisfied.

Adam Smith claimed that the market mechanism works like an invisible hand. What to
produce depends on consumer choice, how to produce the goods and services depend on
the entrepreneur method of choice and for whom to produce will be for those who have the
means to pay for the produce.

No truly free market economy exists in the world. For example, while America is a capitalist
nation, our government still regulates (or attempts to regulate) fair trade, government
programs, moral business, monopolies, etc. etc. The advantage to capitalism is you can
have an explosive economy that is very well controlled and relatively safe. This would be
contrasted to socialism, in which the government (like a command economy) controls and
owns the most profitable and vital industries but allows the rest of the market to operate
freely; that is, price is allowed to fluctuate freely based on supply and demand.

Market Economy and politics: Arguably the biggest advantage to a market economy (at
least, outside of economic benefits) is the separation of the market and the government. This
prevents the government from becoming too powerful, too controlling and too similar to the
governments of the world that oppress their people while living lavishly on controlled
resources. In the same way that separation of church and state has been to vital to
America’s social success, so has a separation of market and state been vital to our
economic success. Yes, there is something wary about a system which to be successful
must foster constant growth, but as a result progress and innovation have occurred at such
incredible rates as to affect the way the world economy functions.

4. Mixed Economic System

A mixed economic system (also known as a Dual Economy) is just like it sounds (a
combination of economic systems), but it primarily refers to a mixture of a market and
command economy (for obvious reasons, a traditional economy does not typically mix well).
As you can imagine, many variations exist, with some mixed economies being primarily free
markets and others being strongly controlled by the government.

Benefits of a Mixed Economy: In the most common types of mixed economies, the market
is more or less free of government ownership except for a few key areas. These areas are
usually not the resources that a command economy controls. Instead, as in America, they
are the government programs such as education, transportation, USPS, etc. While all of
these industries also exist in the private sector in America, this is not always the case for a
mixed economy.

Disadvantages of a Mixed Economy: While a mixed economy can lead to incredible

results (America being the obvious example), it can also suffer from similar downfalls found
in other economies. For example, the last hundred years in America has seen a rise in
government power. Not just in imposing laws and regulations, but in actually gaining control,
becoming more difficult to access while simultaneously becoming less flexible. This is a
common tendency of mixed economies.

A current, pivotal debate between Democrats and Republicans is the amount of

governmental control. Can a true balance exist? Where should there be more government
regulation? Where should there be less? These questions have no real answer; it is
subjective, and therefore only a relatively small portion of the population will, at any given
time, agree with the state of a mixed economy. It must be a strong form of government
indeed to avoid collapsing under this constant pressure.

The function of prices in the market economy

The rationing function of prices (distribution)

The scarce goods and services produced by scarce resources are “rationed / distributed”
among the citizens of a nation to those who is able to buy it. This means that those who
have money (demand) will be able to obtain the goods (bread, milk, a car, a house). The
price indicates to the buyer with how much he/she must part with to obtain the good or
service.

When you walk through a shopping mall you will see how the products in the window of a
shop communicate with you, saying “by me I am only R100-00”. When you buy the
product you have been rationed with it (the product was distributed to you).You were able
to receive the distributed product because you had the means to pay for it.

Where did you get the means? You have a job and have been rewarded for your labour a
wage. Thus for participating in the production of a country you are rewarded with an income
and the income makes it possible that goods and services of your choice can be rationed
(distributed) to you. If you have no income (decide not to work) you will not receive the
produce or be rationed with goods and services.

The allocating function of prices

Prices serve as a signal which directs the factors of production (land capital labour and the
entrepreneur) between different uses in the economy.

Assume that in the market for laptops tablets and cell phones good profits can be made.
The entrepreneur will attempt to start a business either selling or manufacturing these
products. The reward “profit” is high and thus the entrepreneur will move to the industry of
the said goods. He /she will be willing to pay a higher wage to draw qualified labour. Capital
is also in need and because of the good profit outlook, he/she is willing to pay more interest
to obtain capital and a higher rent to obtain land.

Thus, the allocative function refers to the moving of resources between firms who places the
highest bid on them (pays the better reward)

When profits fall and the rewards cannot be maintained the resources will move away from
the firm to another firm who is willing to pay a higher reward.

Rationing function refers to the price system rationing goods and services among the
citizens of the country and allocative function refers to the direction the resources will
move between firms based upon the price the firm is willing to pay for each factor of
production

It is clear that money votes count in the market economy. The price indicates what the buyer
must part with to obtain the good service or factor of production. If the citizen has no income,
he/she is NOT able to participate in this market process.

Distribution of income is thus a very important issue in a country where we experience a high
unequal distribution of income. This topic is studied in macroeconomics.

Other view points on the advantages of Mixed Economy

[Link]

Advantages of the mixed economic system

1. Since mixed economy involves both government and private enterprises it has the
advantage of taking the benefits of capitalist nature of private companies and
socialist nature of government.
2. There is less inequality of income because intent of government is to have a
balanced economic growth of an economy.
3. Mixed economy allows individuals to run their business and make profits but at the
same time it places some responsibility on these companies by inducing them to
contribute towards the welfare of society.

Disadvantages of Mixed Economy

 1. Since welfare of society is important in a mixed economy it leads to lower than
optimum use of the resources because government mobilize the resources towards
the production of those goods and services which are beneficial for the society as a
whole rather than producing those goods and services which in economic terms are
more beneficial for an economy.
2. Under mixed economy private enterprises have to face lot of difficulty because of
various government loopholes like favoritism and bureaucratic nature which is
prevalent in mixed economy.

Phillip Mohr & associates 2015; 26

Regards,

Dr GG van Gend

Below an extraction from the internet

The purpose of an economic system is to give answers to

three questions: What-, How-, and for whom to produce.

Advantages and Disadvantages of Traditional Economy

Traditional economy can be defined as an economy which is based on customs and

beliefs which people get from generation to generation. In simple words it is the
economic system in which resources are allocated by inheritance. Economic activity
is usually secondary to religious and cultural values.

Traditional economy has some advantages as well as disadvantages here are some
of them.

Disadvantages of the traditional economic system

The main advantage of traditional economy is that this type of economics produces
only those goods and services which are required for the survival or which they want
to consume. Hence there is no surplus or wastage and hence it does not waste
resources for goods and services which are unnecessary. Also in this economy
people know exactly what their roles or job is and hence there is no duplication of
effort.

Advantages of the traditional economic system

However, it suffers from certain disadvantages like this type of economy resist any
changes because they tend to think that methods and procedures which are followed
by their ancestors for generations are correct and hence which in turn leads to lower
productivity thus leading to lower development of the society or country. Also, due to
this lower productivity people have lower standard of living than other economies
which does not follow traditional economics. Also in this type of economies people
must do a job which they are told to do but which they don’t like and hence it also
lowers their productivity.

Advantages and Disadvantages of Centrally Planned Economy

A centrally planned economy is an economic system where the government makes

decisions for the economy, instead of interacting between businesses and
consumers. The government prepares a central plan to give answer to what-, how-,
and for whom to produce.

Unlike a market economy, where business owners and private citizens can make
production decisions, this form of economy controls the production and distribution of
products, as well as the use of resources. Also, enterprises that are owned by the
state undertake the production of goods and services.

However, like any other economic system, centrally planned economy has also been
a topic of debates, with both sides pushing valid points. To build an opinion about
this matter, it is best to assess its advantages and disadvantages.

Advantages of Centrally Planned Economy

1. It promotes equality among consumers.
Since the government controls all aspects of production, there will be no chance of
monopoly to occur, which means that the gap between the rich and the poor will be
reduced, as all government policies will be designed to bring about social equality.
2. It allows the government to monitor all aspects of economy.
In a centrally planned economy, the government will be able to keep proper tabs on
the supply, demand, prices and other aspects surrounding goods and services. It
can also indirectly keep a watch on any signs of inflation that might occur.

3. It does not hinder economic projects to be carried out immediately.

There will be no need to wait for private investments for particular projects to go
underway, unlike in other economic systems, such as capitalism. Here, the
government reigns supreme, which means that it can start and end a project that the
country might require, such as infrastructures, health facilities and sanitation
services.

List of Disadvantages of Centrally Planned Economy

1. It is known to be inefficient in distributing resources.

This economic system sees planners not being able to accurately predict shortages,
surpluses and consumer preferences, which entails that they cannot also allocate
resources efficiently. This would result in some areas having abundance of goods
that cannot be sold and other areas experiencing shortages. On the other hand, a
free market allocates resources based on the price system, making sure they will go
where demand and supply are dictated.

2. It would go against some people’s rights as consumers.

Opponents say that this system will lead to dissent among citizens, as their basic
right of free will is going to be challenged. This means that it will eventually lead to
the citizens revolting against the government.

3. It suppresses economic freedom.

It has been observed that a centrally planned economy can stifle economic freedom,
as citizens would have no incentive to take entrepreneurial risks or innovate. As you
can see, central planners suppress the profit motive by considering decisions from
entrepreneurs and transferring them to the state. As economists believe, society
functions best when the economy is guided by invisible hand, which rewards
personal economic freedom, but central planning restricts this strategy.
Like any other economic concept, a centrally planned economy can be very difficult
to understand. However, by weighing down its advantages and disadvantages, you
will be able to know if it is right for your society, or not.

Market Economy
Market economy is based on supply and demand where the prices of goods and
services are determined within a free price system. Market prices constitute a
signalling system. Prices have the function of rationing and allocating.

This system encourages economic freedom and was set up so that it would regulate
itself due to money flowing where the demand is greatest and encouraging
competition and initiative. According to Adam Smith, the market mechanism works
like an invisible hand which coordinates the selfish actions of individuals, and in the
attempt of seeking one’s own interest, one serves the community the best.
Competition is an important feature of the system

The market economy is characterised by individualism, private freedom,

decentralised decision making and limited government intervention.

The question of what to produce are answered by consumers choice, how to

produce is answered by the entrepreneur (the firm) and for whom to produce are
produced for those who have the means to pay for them.

There are many advantages and disadvantages of market economy which are
described briefly below.

Advantages of the Market Economy

Market economy has several advantages. Having a healthy competition and a
system that encourages entrepreneurship is important in any market. Below are
some of the major pros of market economy.

1. Harder working employees due to the threat of losing their job or being laid off
because the product or service is not selling.
2. Friendly competition between companies will encourage efficiency among
employees to lower costs for success.
3. Companies become creative in finding new products to sell or manufacture and
less expensive ways to accomplish their goals.
4. As companies grow because of the market economy, foreign investors will
begin to take an interest and help expand.
5. Private companies take over activities and venues that were in the past public
sector. This reduces the size, power and cost of state bureaucracies.
6. Production increases for the frivolities that will cost more money, but people
want. This is a classic example of supply and demand.
 7. Social and technical skills needed to function within a market economy system
are quickly learned as is the knowledge to succeed.
8. There is a larger variety of consumer goods available for a wide range of
people ranging from middle-class to the very affluent.
9. Encourages people to step up and try their hand in the market economy.
Encourages entrepreneurs to start up a business and sell merchandise or offer
services at competitive rates.

Disadvantages of the Market Economy

Although the market economy system sounds ideal, there are always problems with
any type of economic system. Here are some of the disadvantages of the market
economy system.

1. The exploitation of workers has a big disadvantage because of the working

conditions, long hours for less pay for a very few benefits. The large
corporations have moved their production to countries where they can get
cheap labour with few safety regulations for the workers.
2. Investment priorities and wealth becomes distorted. The wealthy keep getting
wealthier and the public sector such as public education, transportation routes
and public health does not get the needed funds to keep evolving and
providing for the public’s needs.
3. Goods will be mass produced and therefore the cost will be driven lower. As a
product becomes popular and overproduced, the manufacturers must unload
the goods, even if that means lowering prices to where the public can afford
them.
4. Due to overproduction, industrial machinery will lay idle and there will be
no production or profit for the manufacturer. Until the prices drop, the goods will
remain unsold and people who cannot afford them have their needs unmet.
5. Unemployment rates go up due to the overproduction of goods. Workers are
not needed to keep producing goods and therefore companies cannot afford to
keep workers employed.
6. Having the market economy system will lead to periods of economic crisis. The
economy will stop growing when goods are overproduced, and workers are
then unemployed. The economic crisis will not end until the next item is found
that the wealthy just must have. Then the cycle starts again.

Advantages and Disadvantages of the Mixed Economy

As the name implies, a mixed economy is a form of system where all activities in
production, as well as those performed by private and government entities,
blends capitalism with various kinds of regulations.

The mixed economic system is a mixture of the traditional-, command-, and

market system
However, more and more people these days are wondering what this type of
economy is all about, causing them to study it and discover its advantages and
disadvantages. It is best to consider these things to be able to know where we
stand on this matter.

Advantages of the Mixed Economy

1. It promotes a quick economic development.
In this type of economic system, both the public and private sectors can operate
equally, which means that economic development will be quicker. This is
especially true considering that economic resources will be utilized efficiently.
Also, depletion of resources will be slowed down.

2. It creates a balance in regional developments.

The planning commission of a country will be able to create policies for the
improvement of every region. In addition, the government would also try to
develop each sector of the population.

3. It encourages lesser income inequality.

With a mixed economy, there will be lesser inequality when it comes to income,
where the inheritance law is applied to enable members of society to become
richer. As for the public sector, it would try to provide economic utility to the
public, leading to further reduction of inequality in income.

4. It provides the freedom to own a private property.

People are free to obtain property in a mixed economy, which means that the
idea to work even more will be encouraged. Again, this will help in the fast-
economic development, especially in the areas of industries and agriculture.

Disadvantages of the Mixed Economy

1. It brings about the fear of nationalization.
As the private and public sectors coexists, the government would have the ability
to own and nationalize any industry. This means that private entities will have to
stay on the psychological apprehension that their business would be nationalized
or taken over by the government.
2. It could risk the government to go too far.
In a mixed economy, determining the exact role of the government in the private
sector would sometimes become a guessing game that would result to unfair
practices in both sides. It is believed that the government would manage the
economy poorly, so its involvement is usually regarded as inappropriate.
3. It observes lesser use of resources.
While the interest of the society is important in this system, it also hinders
maximum use of available resources. This is primarily because of the
government trying to mobilize resources to produce products and services that
are generally beneficial for society, rather than doing it for the betterment of the
economy.
4. It can lead to higher taxes.
With more state intervention in the economy, it would mean that the government
would invest more and would get their funds largely from tax revenues. More
taxes would be required from the people, which can lead to negative
consequences.
Basically, the success or failure of a mixed economy would still depend on how it
is managed. However, based on the advantages and disadvantages listed above,
we will be able to know whether it will do our country any good or just make
situations even worse.