Transcript economic systems

LESSON : ECONOMIC SYSTEMS
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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
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.
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.
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.
The Market Driven Economy:
• In this type of economy, private individuals
(and not the Gov’t), 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.
Key features of a free market economy:
1. There is very little gov’t 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;
Key features of the free market economy
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Ownership of all profits after payment of taxes;
By driving costs down, in order to maximize
competitiveness, the system tends to disadvantage
labour with low wages;
7. It also tends to suppress trade unions, regarding their
demands as a curb on market freedom;
8. By maximizing profit, it tends to promote actions that
may be against the public interest, e.g. monopoly
pricing, shoddy goods, tax evasion;
9. Monopolies are allowed to proliferate – they help gov’t
by paying high taxes, and may also support political
parties in fighting elections;
10. Laws, rules and regulations have to be introduced to
protect consumers from unscrupulous traders.
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.
Advantages of the free market system
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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.
There is very little gov’t intervention in the market
economy. As a matter of fact, there is a lack of gov’t
intervention.
There is a greater degree of competition as goods and
services providers scramble for a share of the market.
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 Gov’t 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.
Disadvantages of free market system
4. 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.
5. Too much money may be spent on
advertising to attract customers.
6. The price mechanism may work
sluggishly and as a result suppliers will
react slowly to demand changes.
Disadvantages of the free market system
7. 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.
8. Resources can remain unused if it is thought
they will not yield a profit.
9. When gov’ts intervene with legislation to
control undesirable actions (e.g. controlling
pollution through large fines), firms tend to
raise prices to cover their increased costs.
The Planned Economy:
In this type of economy, all the resources
are owned by the State (or Gov’t 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.
Key features of planned economies:
1. A gov’t 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;
2. Central authorities decide what to produce, how to
produce, who gets the output and how much they get;
3. 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.
Key features of the controlled economy
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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;
Citizens live in a highly regimented society, with gov’t
officials, police or even soldiers on nearly every street
corner – even on farms, to check on production
Oppression, high unemployment and poverty are
prevalent;
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.
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.
Advantages of the planned economic system
3. 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.
4. 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.
5. Income is more evenly distributed.
Advantages of the planned economic system
6. Workers may tend to increase their
efficiency since they may feel that they
are working both for themselves and for
their country.
7. The monopoly power of the State can be
used for the welfare of the society as a
whole.
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 Gov’t protects workers by setting a
minimum wage (which may be inadequate or
subsistence)
Disadvantages of the planned system
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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.
Gov’t can freely intervene in areas where there is an imbalance to
protect the firm or the consumers from unfair practices.
Production usually takes place ahead of demand and this could
lead to waste as once the consumer’s 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 Gov’t can impose its choices on the rest of
the society, for e.g., producing more military goods and fewer
consumer goods.
Disadvantages of the planned economic system
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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.
The Mixed Economy:
• In this system both the gov’t 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 gov’t 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 gov’t 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.
Key features of a mixed economy (in the region):
1. There has been a marked rise in the formation of nongovernmental 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;
2. Consistent with this weakening of the public sector in
the region, there has been a strengthening of private
sector participation as gov’ts 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;
Key features of the mixed economy
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There is more trade union activity than in a planned
economy, where trade unions might hardly exist;
A greater premium is placed on consumer protection,
and there is zero tolerance of environmental pollution;
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;
Tourism has become the main attraction for most
investment, replacing traditional investment interest,
e.g. sugar, bananas or oil, according to the country;
Key features of mixed economies
7. 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 gov’ts;
8. There is growing dependency on foreign aid,
imports and the transfer of technology from
developed countries. T&T 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;
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 gov’t 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).
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 gov’t regulation may dampen the
free enterprise spirit.
3. Some Sate-owned industries are allowed to
operate inefficiently thus wasting resources.
4. Where gov’t 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.
Comparison of the three economic systems:
• The goal of all three economic systems is the efficient
allocation of the society’s 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 gov’ts.
• 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 gov’t.