This article navigates 4 types of economic systems and their pros and cons. It answers questions like “What are the different types of economic systems?,” In reading through the write-up, learners will gain a firm grasp of the various economic systems and how they apply to modern society.
Table of Contents
- What is an Economic System?
- Final Word
What is an Economic System?
An economic system is a means by which societies or governments organize and distribute available resources, services, and goods across a geographic region or country.
Economic systems regulate the factors of production, including land, capital, labor, and physical resources. An economic system encompasses many institutions, agencies, entities, decision-making processes, and patterns of consumption that comprise the economic structure of a given community.
Types of Economic Systems
There are many types of economies around the world. Each has its own distinguishing characteristics, although they all share some basic features. Each economy functions based on a unique set of conditions and assumptions.
Economic systems can be categorized into four main types: traditional economies, command economies, mixed economies, and market economies.
1. Traditional economic system
A traditional economic system is based on customs, history and time-honored beliefs.
A traditional economy is an economic system in which traditions, customs, and beliefs help shape the goods and services the economy produces, as well as the rule and manner of their distribution. Countries that use this type of economic system are often rural and farm-based.
Also known as a subsistence economy, a traditional economy is defined by bartering and trading. A little surplus is produced and if any excess goods are made, they are typically given to a ruling authority or landowner.
A pure traditional economy has had no changes in how it operates (there are few of these today). Examples of these traditional economies include those of the Inuit or those of the tea plantations in South India.
Traditional economies are popularly conceived of as “primitive” or “undeveloped” economic systems, having tools or techniques seen as outdated. As with the notion of contemporary primitiveness and with modernity itself, the view that traditional economies are backward is not shared by scholars in economics and anthropology.
- Simple division of work. Since traditional economies are composed of tightly knit families and communities, the people already know what to do and, in some cases, already have preexisting roles prior to working.
- Minimal wastage. Workers in traditional economies know the maximum capacity of their work areas, be it a plot of farmland or a fishing site, and therefore produce goods in sufficient quantities with limited excess.
- Earth-friendly. With the land as the source of their trade and basic necessities, their working measures don’t produce as much industrial waste as the other types of economic systems. They also don’t have access to a lot of modern equipment that produce harmful emissions in large volumes.
- Socially satisfied populace. Family, community, and religious ties hold more weight than business profits. The norms that bind the economy are upheld.
- Money is in the hands of only a few. A large brunt of the profits earned in traditional economies is in the hands of powerful entities like extended families and corporations, and the same goes for the surplus generated.
- Limited progress. Technological advancements that streamline processes and increase outputs and output quality are hard to come by in traditional economies. The resources are limited and the deployment of such is largely controlled by corporations and aristocrats. This also lends to the lack of centralized utilities in rural areas.
- A low cap on profits. Since the operations are largely localized and whatever surplus generated is appropriated by powerful entities, the profits obtained by producers are modest. Many of the people are at the subsistence level.
- Limited access to medicine. The largely localized ecosystems in the agrarian areas is not profitable enough for investors to ply their trade there, thus the inflow of Western medicine is reliant on imports. Also, the resources necessary to produce Western medicine are scarce.
2. Command economic system
command economy, economic system in which the means of production are publicly owned and economic activity is controlled by a central authority that assigns quantitative production goals and allots raw materials to productive enterprises.
In such a system, determining the proportion of total product used for investment rather than consumption becomes a centrally made political decision. After this decision has been made, the central planners work out the assortment of goods to be produced and the quotas for each enterprise.
Consumers may influence the planners’ decisions indirectly if the planners take into consideration the surpluses and shortages that have developed in the market. The only direct choice made by consumers, however, is among the commodities already produced.
Prices are also set by the central planners, but they do not serve, as in a market economy, as signals to producers of goods to increase or decrease production. Instead, they are used mainly as instruments of the central planners in their efforts to reconcile the total demand for consumer goods with the supply available, allowing also for revenues to the state.
- Affordably-priced capital goods. The margins are lowered when command economies sell capital goods to their citizens. After all, they receive a bulk of their profits from international trade.
- Jobs for everyone. With the government controlling the industrial sector, it creates countless jobs for its citizens, ideally taking everyone within its jurisdiction into account. This, in effect, also reduces the number of homeless and hungry people.
- Plans are easily rolled out. Since the government has complete control over production, it can execute economically sound plans without any roadblocks. This could potentially raise a country’s GDP in the long run or provide citizens with projects like universal healthcare.
- Less inequality. The work, pay, and positions of people in the industrial sector are dictated by the government. So those in lateral positions should more or less receive the same compensation.
- Inefficient procedures. While production plans may go unimpeded, the processes by which those initiatives are executed might not receive upgrades since the government is the only player in the market. The absence of competition could also lead to substandard goods.
- Prone to abuse. Too much power in the hands of one entity leads to laws or rules that infringe on human rights and workers’ rights. For instance, the state can mandate shifts that exceed 12 hours to achieve a particular quota. Not meeting the desired quantity of outputs could lead to serious financial consequences.
- Inferior products. The strict quotas mandated by a command economy can lead to workers cutting corners in production, resulting in subpar products. Oddly low projections may also be given by workers just so their quotas will be reduced.
- Uneven distribution of commodities. It is not easy for central planners to come up with the exact type and quantity of commodities to be afforded to citizens since the needs of individuals and households vary. This can lead to an oversupply in certain consumer goods and a scarcity in others.
3. Market economic system
A market economy is an economic system where two forces, known as supply and demand, direct the production of goods and services. Market economies are not controlled by a central authority (like a government) and are instead based on voluntary exchange.
Market economies rely on the interplay between supply and demand to function. “Demand” refers to the amount of goods and services people need or want. “Supply” refers to the amount of goods and services available for purchase. If the supply is low while the demand is high, it drives up the price that someone can charge for it.
Conversely, if there is a greater supply of a certain good and people do not want it as much, the price will go down. The levels of supply and demand for any given good or service tend to move toward an equal balance but this equality, if achieved, cannot be held for long, so the tension between supply and demand creates a fluctuating market.
- Constant innovation. As enterprises try to gain a larger share of the market, they constantly improve on their products or services, incorporating new technologies and methods wherever possible.
- Economic growth. With enterprises helming their respective industries, goods are produced at a fast pace, with surpluses coming in huge numbers. This leads to growth in an economy
- Responsive to public demand. The decentralized market features a multitude of producers trying to gain a larger share in profits. To do that, they have to meet the demands of the buying public and sometimes exceed them to outperform their competitors.
- Fosters economic activity. New players are welcome to ply their trade on the market, whether one opens a business or gets employed, to make money. Individuals have the freedom to find ways to earn as long as they are within the bounds of the law.
- Inequality in wealth. Wealth is concentrated on those who hold power in the economy. The poor do not have access to a lot of opportunities that can make them wealthy.
- High risk. While people are welcome to open businesses, succeeding in those ventures is an entirely different matter. The competition is fierce in high-demand industries and those who do not have sufficient capital will likely lose a price war with corporate giants.
- Hard to enter high-paying jobs. Due to the fierce competition in the market, finding a job that pays well is not easy. Some people experience stagnation in their incomes while others see their job prospects erode.
- Environmental damage. A lot of manufacturers operate in factories that produce harmful emissions. For them, finding earth-friendly solutions is too tedious and costly.
4. Mixed system
A mixed economic system is a system that combines aspects of both capitalism and socialism. A mixed economic system protects private property and allows a level of economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims.
According to neoclassical theory, mixed economies are less efficient than pure free markets, but proponents of government interventions argue that the base conditions required for efficiency in free markets, such as equal information and rational market participants, cannot be achieved in practical application.
- Free market. Although mixed economies vary, the industrial sectors in most economies are controlled by private firms. Competition breeds innovation and progress, while collective industrial effort boosts a country’s economic performance.
- More sectors covered. Producers in market economies focus on the most profitable industries, leaving other sectors out. In mixed economies, the government can enter and fill in those gaps, as it takes control of areas like defense and agriculture.
- Partially addresses the inequality in market economies. Once again, the government’s entry can help individuals and small organizations that do not have the resources to compete with their corporate counterparts. Subsidies and tax breaks, among other incentives, can be released.
- Strategic taxation. The government can add taxes to certain industries to gain funds in furthering its social objectives.
- Weaknesses of the free market. Like market economies, the competition is fierce and can leave the smaller players folding up or barely surviving. There is huge inequality in the country’s distribution of wealth.
- Weaknesses of the command economy. Increased government control in the industrial sector could curb the flexibility provided by free markets).
- Uneven market regulation. A government, in trying to maintain a free market, might forgo of regulations that promote fair trade. On the other hand, it might end up funding oligarchies and monopolies in the sectors they control.
- Confusion in the government’s role. Determining where the government should and should not intervene is subjective and has been the subject of debates. The prevailing model could end up changing when new government officials are elected to power.
Economic systems are grouped into traditional, command, market, and mixed systems. Traditional systems focus on the basics of goods, services, and work, and they are influenced by traditions and beliefs. A centralized authority influences command systems, while a market system is under the control of forces of demand and supply. Lastly, mixed economies are a combination of command and market systems.