ECONOMIC SYSTEMS

  All economies are faced with the same fundamental economic problem: how to allocate scarce resources to satisfy the infinite wants of its population.

  Economic system: a description of the way an economy uses its institutions, organisations and legislation to allocate resources to produce output and decide who receives that output.

  All economies have to provide answers to three questions:

  The What question: what goods are going to be produced from the scarce resources, ie should cars or cycles be produced. This will have an impact on the amount of resources used in the production of each good

  The How question: how will the goods be produced, ie what method of production should be adopted (eg machines or labour); where should the production take place (eg UK or abroad)

  The For Whom question: who will get the goods when they are produced, ie how will the output be distributed (eg according to amount of income someone has or according to their need or by some arbitrary decision maker)

  There are three types of economic system, each providing its own answers to these three questions.

  Command Economies: all key economic resources (except labour) are centrally or publicly owned, the planning process as dictated by the government allocates resources for the general benefit of the country as a whole. Examples of such countries where the state had a major role to play in the past included the USSR, Eastern European countries like Poland and Hungary, and Asian countries like China. In recent years they have adopted capitalist principles and have moved towards the free market economic system.

  Free Market Economies: all key economic resources are privately owned, resources are allocated through the workings of the price mechanism and the motive for economic activity is personal or private gain.  Textbook examples of such economies include the USA and Hong Kong.

  Mixed Economies: in reality most economies are said to be mixed economies containing both a private sector where economic activity takes place for private gain, and a public sector where social provision for the benefit of everyone is the motive of economic activity. The UK is a good example of a mixed economy where the public sector provides industries like health and education for the benefit of everyone, and the private sector provides industries like washing machines and cars that can be sold for a profit in the market place.  Other examples include Germany, France, Sweden and Canada. In recent years many industries have been transferred from the public sector to the private sector through the process of privatisation. Examples include steel, telecommunications, electricity and gas.

A COMPARISION OF HOW DIFFERENT ECONOMIC SYSTEMS ANSWER THE THREE ECONOMIC QUESTIONS

Free market economy: the market mechanism allocates resources. Market condition set the price of a good and economic agents respond to these price changes. So:

What: if consumers want more of a good they will spend more money on buying that good which will cause its price to rise. In response to the price increase, producers will make more with the aim of making more profit, which requires more resource input. If consumers don’t want a good, its price will fall sending a message to producers to make less, meaning fewer resources are needed. Producers are in business to make profit, so they will switch resources into those activities where they can make the profits. Consumer sovereignty is said to exist because the spending patterns of consumers will dictate to producers what goods they should produce.

How: Producers are in competition with each other, so in order to make as much profit as possible they will need to produce as cheaply as possible. They will use the cheapest resources and produce at the least cost location.

  For Whom: money is the lifeblood of the free market economy and producers want to make as much money as possible. They will therefore only sell the goods to people who have the money to purchase them. If producers gave away the goods, no profit would be made and they would go out of business.

  This module looks at the operation of the free market in more detail. You will look at how the market sets prices and examine its strengths and failings, and also the motive for government intervention in the market place.

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