LESSON : ECONOMIC SYSTEMS

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LESSON ECONOMIC SYSTEMS

• LEARNING OBJECTIVES
• Define what is an economic system
• Identify the three types of economic systems
• Define the term market
• Describe the three forms that a market can take
• Describe the three types of economic systems
• State the advantages and disadvantages of each,
  with examples

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Economic systems defined

• Economic systems refer to the structures which
  have been put in place to deal with the economic
  problem (how scarce resources are allocated among
  competing or conflicting wants). It involves the
  ways in which a society organizes for the
  production and distribution of goods and services
  to satisfy the needs of its people. How the
  society decides to provide for the needs and
  wants of its people will influence the type of
  economic system that is adopted.

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Types of economic systems

• The three main types of economic systems adopted
  by countries are
• The market driven economy, free market economy,
  capitalist economic system, or laissez-faire
  economic system, right wing system
• The planned, controlled, communistic,
  collectivist or command economy, left wing
  system
• The mixed economy, centralist.

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Market defined

• A market is an arrangement in which buyers and
  sellers are brought together to transact
  business. It could be a physical place or it
  could be a situation or a set of conditions that
  facilitates the trading process.

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The Market Driven Economy

• In this type of economy, private individuals (and
  not the Govt), own the resources of the economy.
  The answers to the economic questions of what,
  how and for whom to produce are provided by the
  price mechanism, or system.

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Key features of a free market economy

1. There is very little govt interference (guidance
   and financial aid to private businesses)
2. Market forces of supply and demand largely
   determine prices
3. There is much competition among firms for
   patronage, which keeps prices down but not
   necessarily low
4. Unregulated use of factors of production

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Key features of the free market economy

1. Ownership of all profits after payment of taxes
2. By driving costs down, in order to maximize
   competitiveness, the system tends to disadvantage
   labour with low wages
3. It also tends to suppress trade unions, regarding
   their demands as a curb on market freedom
4. By maximizing profit, it tends to promote actions
   that may be against the public interest, e.g.
   monopoly pricing, shoddy goods, tax evasion
5. Monopolies are allowed to proliferate they help
   govt by paying high taxes, and may also support
   political parties in fighting elections
6. Laws, rules and regulations have to be introduced
   to protect consumers from unscrupulous traders.

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Advantages of the market economic system

1. Manufacturers are free to produce what the
   consumers require, and the consumers in turn are
   free to spend their money as they see fit.
2. Decision-making is not controlled, so there is
   greater participation in the decision on what is
   to be produced to satisfy the needs of the
   consumer.
3. A large variety of goods and services are
   produced to satisfy the needs of the consumer.

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Advantages of the free market system

1. The market economy is adaptable to changes that
   arise from time to time. E.g. if there is any
   shift in the demand for a product or service, the
   economy can adjust to meet the new demand.
   Whether it takes a short or a long time to adjust
   to the new demand depends on the type of, or
   nature of the goods or service involved.
2. There is very little govt intervention in the
   market economy. As a matter of fact, there is a
   lack of govt intervention.
3. There is a greater degree of competition as goods
   and services providers scramble for a share of
   the market.

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Disadvantages of the market system

1. Since the making of a profit is the dominant
   motive of the private sector, only goods or
   services that yield the highest profit will be
   produced. E.g. needed infrastructure such as
   the construction of roads or bridges or the
   provision of security for the defence of the
   country would not find ready investment since
   their use does not usually provide a profit.
2. Consumers could be exploited through the
   imposition of high prices for essential goods if
   there is insufficient competition among producers
   or Govt regulation of businesses.
3. This system can lead to a more unequal
   distribution of income, with the rich get richer
   and the poor get poorer. The rich can bid up the
   prices of luxuries, and resources will be used to
   produce these items rather than necessities.

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Disadvantages of free market system

1. The free market can lead to monopolies which can
   exploit consumers by demanding higher prices for
   certain goods and services because they are the
   only seller in the market.
2. Too much money may be spent on advertising to
   attract customers.
3. The price mechanism may work sluggishly and as a
   result suppliers will react slowly to demand
   changes.

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Disadvantages of the free market system

1. The profit motive may not always lead to maximum
   welfare for the society. E.g., the effect of
   production on pollution and destruction of the
   environment may not be considered.
2. Resources can remain unused if it is thought they
   will not yield a profit.
3. When govts intervene with legislation to control
   undesirable actions (e.g. controlling pollution
   through large fines), firms tend to raise prices
   to cover their increased costs.

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The Planned Economy

• In this type of economy, all the resources are
  owned by the State (or Govt owns and controls
  the factors of production). The State owns and
  runs the factories, mines, farms, transportation
  system, food distribution outlets, among others.
  
• The decision about what to produce, how to
  produce and for whom are made by a centralized
  planning agency.

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Key features of planned economies

• A govt central planning body oversees every
  economic activity and committees are appointed by
  the head of state to take charge of various
  sectors of the economy
• Central authorities decide what to produce, how
  to produce, who gets the output and how much they
  get
• Command economies may be introduced as a response
  to bad planning or poor distribution, but they
  may also suffer from the same problems. When
  production or distribution go wrong, there is no
  alternative source of supply, so that rationing
  can be an unwanted side-effect of a planned
  economy (as experienced by Guyana for many
  years). For the same reason black markets can
  result, drawing on unofficial sources of supply.

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Key features of the controlled economy

1. Much investment is not used on consumer goods but
   on military goods (army tanks, guns, space
   exploration). This was especially the case in
   Russia and China
2. Citizens live in a highly regimented society,
   with govt officials, police or even soldiers on
   nearly every street corner even on farms, to
   check on production
3. Oppression, high unemployment and poverty are
   prevalent
4. Tightly controlled (and often poor) economic and
   social conditions tend to result in
   de-motivation, disaffection and ultimately
   defection of citizens and a brain drain.

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Advantages of a Planned Economy

1. Wastage of resources would be reduced since the
   State makes the decision as to what is produced,
   and directs the resources into these areas.
2. Profits gained from State industries may be used
   to generate further production and expand
   provision of public goods such as hospitals and
   other welfare services. Consideration may also
   be given to the improvement of general working
   conditions of State employees.

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Advantages of the planned economic system

1. Since profit maximization is not the motive,
   there may be greater employment of resources and
   the social cost may be taken into consideration.
   Thus planners can ensure that adequate resources
   go into the production of social (public) goods,
   and advertising can be limited to providing
   information only.
2. Since the State determines the price of goods and
   the amount paid in salaries, then no group of
   workers by themselves can force prices up.
3. Income is more evenly distributed.

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Advantages of the planned economic system

1. Workers may tend to increase their efficiency
   since they may feel that they are working both
   for themselves and for their country.
2. The monopoly power of the State can be used for
   the welfare of the society as a whole.

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Disadvantages of a Planned Economy

1. There may be much inefficiency and wastage of
   resources as the profit motive for production is
   missing. E.g., there may be wastage of manpower
   because large numbers of persons (officials) are
   usually required to do the planning in this
   system than are required in the free market
   system.
2. Conflicts of interest arise because what the
   country needs may not be what the people want
3. The Govt protects workers by setting a minimum
   wage (which may be inadequate or subsistence)

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Disadvantages of the planned system

1. The lack of scope for individual incentives may
   lead to a lack of initiative. Furthermore, since
   people are not free to choose what they want to
   produce, how and in what quantities, initiative
   and morale may be further reduced. In addition,
   the State ownership of resources reduces the
   incentives of the members of the society to work
   harder. Since they are working for the State and
   not for themselves, their effort will not be as
   great.
2. Govt can freely intervene in areas where there
   is an imbalance to protect the firm or the
   consumers from unfair practices.
3. Production usually takes place ahead of demand
   and this could lead to waste as once the
   consumers needs are satisfied, they may not
   purchase goods. In many instances they may find
   the goods to be unattractive or of poor quality.
   Furthermore, it is impossible to estimate
   accurately the needs of the consumers. This may
   lead to shortages of some goods and a glut of
   other goods. Moreover, the Govt can impose its
   choices on the rest of the society, for e.g.,
   producing more military goods and fewer consumer
   goods.

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Disadvantages of the planned economic system

• There is usually a large bureaucracy to
  administer the workings of such a system and the
  problems associated with these tend to arise.
  The needs of society has to be determined and
  their provision has to be arranged by politicians
  and bureaucrats (civil servants) who may not be
  trained in the management of large organizations.
  
• Moreover, large organizations are unwieldy and
  difficult to manage efficiently. This may lead
  to coordination problems. E.g. in the former
  Soviet Union, in spite of goods harvests there
  were episodes of food shortages because there
  were not enough trucks to transport the food.

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The Mixed Economy

• In this system both the govt and the private
  sector participate in making the decisions
  regarding what is to be produced, how to produce
  and for whom to produce. The society recognizes
  the important role of the govt in the provision
  of certain goods and services that are
  large-scale in nature, e.g. education and health,
  road construction and maintenance, social
  welfare, amongst others, and accepts this input.
  The govt undertakes these responsibilities as
  the more efficient provider of such services.
• In this system, trade unions tend to play a more
  powerful role and are in many instances,
  responsible for a faster increase in wage and
  salary rates.

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Key features of a mixed economy (in the region)

• There has been a marked rise in the formation of
  non-governmental organisation (NGOs). These are
  autonomous, or nearly autonomous, bodies in the
  private sector that have been charged with
  running or overseeing the provision of services
  and goods in the public interest
• Consistent with this weakening of the public
  sector in the region, there has been a
  strengthening of private sector participation as
  govts have invited foreign companies to take on
  former public sector responsibilities. In Guyana
  since 1992, for e.g. more than 30 public sector
  enterprises have been privatized there are now
  only a handful of public enterprises

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Key features of the mixed economy

1. There is more trade union activity than in a
   planned economy, where trade unions might hardly
   exist
2. A greater premium is placed on consumer
   protection, and there is zero tolerance of
   environmental pollution
3. With the growth of tourism in the region, some
   industries have mushroomed not just hotel
   building, hotel catering services and the
   hospitality industry, but also telecommunications
   (including cell-phones) and computer based
   technology
4. Tourism has become the main attraction for most
   investment, replacing traditional investment
   interest, e.g. sugar, bananas or oil, according
   to the country

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Key features of mixed economies

1. There is a markedly high level of poverty,
   unemployment and crime. This seems to be the
   most persistent feature of all economic systems
   that have been tried, and of all political
   parties and govts
2. There is growing dependency on foreign aid,
   imports and the transfer of technology from
   developed countries. TT and Jamaica, for e.g.,
   regularly get financial and other types of
   assistance (e.g. ships and aircraft to fight the
   drug trade) from the USA and Britain, and cheap
   loans from Canada, China, Germany and the OPEC
   countries

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Advantages of the mixed economic system

1. The state can intervene in areas of the economy
   through the passing of laws to protect citizens
   from unfair trading practices.
2. Both govt and private sector can cooperate in
   the delivery of certain services through
   franchising as seen in the transport sector and
   hospital catering.
3. It is believed by some that this form of economy
   is more equitable since it avoids the creation of
   huge numbers of poor people (through the
   activities of trade unions who represent
   workers).

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Disadvantages of mixed economies

1. One disadvantage often levelled at this system is
   that the State should not participate in business
   enterprise since they are not efficient managers
   of resources.
2. Too much govt regulation may dampen the free
   enterprise spirit.
3. Some Sate-owned industries are allowed to operate
   inefficiently thus wasting resources.
4. Where govt intervenes in the market by setting
   maximum or minimum prices, this may cause either
   excess demand or supply which may be difficult to
   regulate in the long run.

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Comparison of the three economic systems

• The goal of all three economic systems is the
  efficient allocation of the societys scarce
  resources between competing wants.
• The market economy also tries to preserve
  individual choice in the allocation of those
  resources. Market economies usually have
  democratically elected govts.
• Planned economies strive for equality in the
  distribution of resources among members of the
  society, in addition to their efficient
  allocation. They also try to produce adequate
  amounts of social goods which would not be
  produced by the pure market economy.
• The mixed economy recognizes and tries to solve
  this by leaving those activities which can be
  efficiently done by the private sector in their
  hands. The activities which the private sector
  cannot undertake efficiently are handled by the
  govt.