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1. Classification of Economic Systems
Topic 3. The economic system of society
Economic Systems
• An economic system describes how a
country’s economy is organized
– Because of the problem of scarcity, every country
needs a system to determine how to use its
productive resources
• An economic system must answer 3 basic
questions…
Pure Traditional Economy
• Who decides what to produce?
– People follow their customs and make what their
ancestors made
• Who decides how to produce goods &
services?
– People grow & make things the same way that their
ancestors did
• Who are the goods & services produced for?
– People in the village who need them
2. Property and Property Rights
Economic Systems
• WHAT TO PRODUCE? (What kinds of goods and services
should be produced?)
• HOW TO PRODUCE? (What productive resources are
used to produce goods and services?)
• FOR WHOM TO PRODUCE? (Who gets to have the goods
and services?
The way a society answers these questions determines its
economic system.
Advantages:
1. Every member of the society knows exactly what
they are to do.
2. There is a strong social network.
3. Positions within society are already established.
4. Life is generally stable, predictable and
continuous.
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Disadvantages:
1. This type of society is often very slow to change.
2. It does not take advantage of technological
change.
3. There is relatively little promotion of intellectual
and scientific development.
4. There is inefficient provision of goods and
services.
5. There is inadequate use of skill in relation to the
factors of production.
Pure Command System
• Government makes all economic decisions &
owns most of the property
• Governmental planning groups determine such
things as the prices of goods/services & the wages
of workers
• This system has not been very successful & more
and more countries are abandoning it
Advantages:
1. Full employment of all available resources
2. Government possess the information to be
able to direct resources where they are most
needed.
3. Wasteful competition is avoided
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Traditional Economy
• Examples:
– Villages in Asia and South America; the Inuit tribes
in Canada; the caste system in parts of rural India
Command Economy
• Who decides what to produce?
– Government makes all economic decisions
• Who decides how to produce goods and
services?
– Government decides how to make goods/services
• Who are the goods and services produced for?
– Whoever the government decides to give them to
Disadvantages:
1. No freedom of choice for consumers or producers
2. System is too rigid to adjust when changes occur, can result in
shortages
3. Lack of incentive for workers results in low morale and
efficiency. Managers also are not motivated.
4. There are too many officials, and too much unnecessary
procedure and paperwork (red-tape or bureaucracy)
5. There is wastage of manpower because large numbers of
people are required for central planning.
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Command System Pure Market Economy

• An economic system in which economic
decisions are guided by the changes in prices
• Countries with communist governments have that occur as individual buyers and sellers
Command economies interact in the market place
• Most of the resources are owned by private
• Examples: Cuba, former Soviet Union, North Korea citizens
• Economic decisions are based on Free
Enterprise (competition between
companies)
– Gov. does not tell a business what goods to
produce or what price to charge

Market Economy Advantages:

• Who decides what to produce? 1. Manufacturers are free to produce what the consumers demand and the
consumers in turn are free to spend their money as they see it fit.
– Businesses base decisions on supply and demand 2. The decision of what to produce is not controlled by government or any
and free enterprise (PRICE) single individual/firm. Hence, there is greater participation in the decision-
making process.
• Who decides how to produce goods and 3. A large variety of goods and services are produced to satisfy the needs of
consumers.
services? 4. Prices are determined by the forces of demand and supply (the price
– Businesses decide how to produce goods mechanism).
5. Efficient production is promoted since resources are allocated to their
• Who are the goods and services produced most profitable use.
for? 6. Competition among firms improves quality, keeps prices low and spurs
new technology and innovation.
– consumers

Disadvantages: Market Economy

• There are no truly pure Market economies
1. This system leads to some inequalities as the few rich get richer and the
many poor get poorer.
2. There is much pollution associated with this system especially when
industrialization begins to develop.
3. There tends to be an over-consumption of demerit goods such as alcohol,
cigarettes and drugs.

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Mixed Economy Mixed Economy

• Who decides what to produce? • Most democratic countries fall in this category
– businesses (there are no truly pure Market or Command
• Who decides how to produce goods and economies).
services? • Examples: Brazil, Mexico, Canada, UK, etc.
– Businesses, but the government regulates certain
industries
• Who are the goods and services produced for?
– consumers

Which Economic System Is Best? The Index of Economic Freedom

• Market system has proven to be best • The Index of Economic Freedom is an annual
because it promotes the goals of growth, index and ranking created by The Heritage
freedom, & efficiency Foundation and The Wall Street Journal in
– Citizens are free to own their own property and 1995 to measure the degree of economic
use it in the most efficient and profitable way
freedom in the world's nations.
• Command and Traditional systems
sometimes offer more security, but are not
nearly as strong in efficiency, growth,
freedom, and environmental quality

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Types of Economics on the Basis of
Level of Development
• Developed economy
• Developing economy
Resources and goods can be owned by:
• individuals,
• associations,
• governments
Property rights can be viewed as an attribute of
an economic good.
This attribute has four broad components and is
often referred to as a bundle of rights:
• the right to use the good
• the right to earn income from the good
• the right to transfer the good to others
• the right to enforcement of property rights
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Property
• Property is the ownership of resources or
other tangible objects, or intellectual property
• Property is usually considered to be
ownership and control over a resource or
good
Property rights
• Property rights are theoretical constructs
in economics for determining how goods are used
and owned
• Economic theory contends that government
enforcement of strong property rights is a determinant
regarding the level of economic success seen in the
area.
• Individuals will create new forms of property to
generate wealth, only when they are assured that their
rights to their property will protect them against unjust
and/or unlawful actions by other parties.
• Property rights to a good must be defined,
their use must be monitored, and possession
of rights must be enforced.
• The costs of defining, monitoring, and
enforcing property rights are termed
transaction costs.
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Transaction costs are costs incurred in making an economic
exchange
Transaction costs can be divided into three broad categories:
• Search and information costs are costs such as those
incurred in determining that the required good is available
on the market, which has the lowest price, etc.
• Bargaining costs are the costs required to come to an
acceptable agreement with the other party to the
transaction, drawing up an appropriate contract,
negotiation and so on.
• Policing and enforcement costs are the costs of making sure
the other party sticks to the terms of the contract, and
taking appropriate action (often through the legal system) if
this turns out not to be the case.
Privatization
• it is the process of transferring ownership of a
business , enterprise, agency, public service,
or public property from the public sector (a
government) to the private sector
Nationalization
• Nationalization (an alternative spelling
is nationalisation) is the process of taking a
private industry or private assets into public
ownership by a national government or state
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Property-rights regimes
• State property (also known as public property) is
property that is owned by all, but its access and
use are controlled by the state. An example is a
national park.
• Common property or collective property is
property that is owned by a group of individuals.
Access, use, and exclusion are controlled by the
joint owners.
• Private property: access, use, exclusion and
management are controlled by the private owner
or a group of legal owners
Methods of privatization
There are three main methods of privatization:
• Share issue privatization - selling shares on
the stock market.
• Asset sale privatization- selling an entire
organization (or part of it) to a strategic investor,
usually by auction
• Voucher privatization - distributing shares of
ownership to all citizens, usually for free or at a
very low price.
• Privatization from below- Start-up of new private
businesses in formerly socialist countries.