Economic Systems

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
▪ Scarcity = not having enough of something
▪ An economic system must answer 3
questions…
 Economic Systems
1. WHAT TO PRODUCE? (What kinds of goods and
services should be produced?)

2. HOW TO PRODUCE? (What productive resources are

used to produce goods and services?)

3. FOR WHOM TO PRODUCE? (Who gets to have the

goods and services?
Three Types of Economic
Systems:
▪ 1. Traditional Economy

▪ 2. Command Economy

▪ 3. Market Economy

▪ * Most countries are… Mixed Economies!

(Market + Command)
 Traditional Economy
▪ An economic system in which economic
decisions are based on customs and beliefs
▪ People will make what they always made &
will do the same work their parents did
▪ Exchange of goods is done through
Bartering: trading without using money
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
Traditional Economy

▪ Examples:
▪ Villages in Africa and South America
▪ the Inuit tribes in Canada
▪ the caste system in parts of rural India
▪ the Aborigines in Australia
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
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
Command System

▪ Countries with communist governments have

Command economies

▪ Examples: There are no truly pure command

economic systems, but close countries are:
North Korea, former Soviet Union, Cuba

*Germany and Russia have moved away from

having a Command economy since 1991. Now they
have a Mixed economy.
Market Economy
▪ An economic system in which production
and distribution questions are answered by
prices and profits (supply and demand)
▪ Most of the resources are owned by private
citizens
▪ Economic decisions are based on Free
Enterprise (competition between
companies)
▪ Important economic questions are not answered
by gov. but by individuals
▪ Gov. does not tell a business what goods to
produce or what price to charge
Market Economy

▪ Who decides what to produce?

▪ Businesses base decisions on supply and demand
and free enterprise (PRICE)
▪ Who decides how to produce goods
and services?
▪ Businesses decide how to produce goods
▪ Who are the goods and services
produced for?
▪ consumers
Market Economy

▪ There are no truly pure Market economies,

but the United States is close.
▪ In a truly free market economy, the
government would not be involved at all
▪ There would be no laws to protect workers form
unfair bosses
▪ There would be no rules to make sure that
credit cards were properly protected

▪ Many societies have chosen to have some

rules to protect consumers, workers, and
businesses (MIXED)
▪ These rules reduce the freedoms that businesses
have, but they also protect the workers and
consumers
 Mixed Economy
▪ Market + Command = Mixed
▪ There are no pure command or market
economies.
▪ To some degree, all modern economies exhibit
characteristics of both systems and are often
referred to as mixed economies.
▪ Most economies are closer to one type of economic
system than another
▪ Businesses own most resources and determine
what and how to produce, but the
government regulates certain industries
Mixed Economy

▪ Who decides what to produce?

▪ businesses
▪ Who decides how to produce goods and
services?
▪ Businesses, but the government regulates
certain industries
▪ Who are the goods and services produced
for?
▪ consumers
Mixed Economies
▪ Most democratic countries fall in this
category (there are no truly pure Market or
Command economies).
▪ Examples: Brazil, Mexico, Canada, UK, US,
Germany, Russia, Australia, etc.
 Economy Continuum
Command Market

Germany UK US
Cuba Russia Australia
Which Economic System Is Best?
▪ Market system has proven to be best
because it promotes the goals of growth,
freedom, & efficiency
▪ Citizens are free to own their own property and
use it in the most efficient and profitable way
▪ Command and Traditional systems
sometimes offer more security, but are not
nearly as strong in efficiency, growth,
freedom, and environmental quality
 COMMUNISM

INTRODUCTION

Communism is a political and economic doctrine that aims to replace private property and
a profit-based economy with public ownership and communal control of at least the major
means of production (e.g., mines, mills, and factories) and the natural resources of a
society

Communism is a form of government most frequently associated with the ideas of Karl
Marx, a German philosopher who outlined his ideas for a utopian society in The
Communist Manifesto, written in 1848.

Marx believed that capitalism, with its emphasis on profit and private ownership, led to
inequality among citizens. Thus, his goal was to encourage a system that promoted a
classless society in which everyone shared the benefits of labor and the state government
controlled all property and wealth.

No one would strive to rise above others, and people would no longer be motivated by
greed. Then, communism would close the gap between rich and poor, end the exploitation
of workers, and free the poor from oppression.

The basic ideas of communism did not originate with Marx, however. Plato and Aristotle
discussed them in ancient times, but Marx developed them into a popular doctrine, which
was later propelled into practice.

Marx’s ideal society ensured economic equality and fairness. Marx believed that private
ownership of property promoted greed, and he blamed capitalism for society’s problems.
The problems, he claimed, stemmed from the Industrial Revolution.

The rise of factories, the reliance on machines, and the capability of mass production
created conditions that promoted oppression and encouraged the development of a
proletariat, or a working class.
Simply put, in a capitalist system, the factories fueled the economy, and a wealthy few
owned the factories. This created the need for a large number of people to work for the
factory owners. In this environment, the wealthy few exploited the laborers, who had to
labor in order to live.

So, Marx outlined his plan to liberate the proletariat, or to free them of the burden of labor.
His idea of utopia was a land where people labored as they were able, and everyone
shared the wealth.

Marx identified two phases of communism that would follow the predicted overthrow of
capitalism: the first would be a transitional system in which the working class would control
the government and economy yet still find it necessary to pay people according to how
long, hard, or well they worked, and the second would be fully realized communism—a
society without class divisions or government, in which the production and distribution of
goods would be based upon the principle

HISTORICAL BACKGROUND

Marx had begun to lay the theoretical and (he believed) scientific foundations of
communism, first in The German Ideology (written 1845–46, published 1932) and later in
Das Kapital (1867; Capital).

His theory has three main aspects: first, a materialist conception of history; second, a
critique of capitalism and its inner workings; and third, an account of the revolutionary
overthrow of capitalism and its eventual replacement by communism.

Historical Materialism

According to Marx’s materialist theory, history is a series of class struggles and

revolutionary upheavals, leading ultimately to freedom for all.

According to Marx, material production requires two things: “material forces of

production”—roughly, raw materials and the tools required to extract and process them—
and “social relations of production”—the division of labour through which raw materials
are extracted and processed.
In primitive societies the material forces were few and simple—for example, grains and
the stone tools used to grind them into flour. With the growth of knowledge and technology
came successive upheavals, or “revolutions,” in the forces and relations of production
and in the complexity of both.

For example, iron miners once worked with pickaxes and shovels, which they owned, but
the invention of the steam shovel changed the way they extracted iron ore. Since no miner
could afford to buy a steam shovel, he had to work for someone who could.

Industrial capitalism, in Marx’s view, is an economic system in which one class—the ruling
bourgeoisie—owns the means of production while the working class or proletariat
effectively loses its independence, the worker becoming part of the means of production.

Critique of capitalism

The second aspect of Marx’s theory is his critique of capitalism. Marx held that human
history had progressed through a series of stages, from ancient slave society through
feudalism to capitalism.

In each stage a dominant class uses its control of the means of production to exploit the
labour of a larger class of workers. But internal tensions or “contradictions” in each stage
eventually lead to the overthrow and replacement of the ruling class by its successor.

Marx acknowledged that capitalism was a historically necessary stage of development

that had brought about remarkable scientific and technological changes—changes that
greatly increased aggregate wealth by extending humankind’s power over nature.

The problem, Marx believed, was that this wealth—and the political power and economic
opportunities that went with it—was unfairly distributed. The capitalists reap the profits
while paying the workers a pittance for long hours of hard labour.

Under capitalism, Marx claimed, workers are not paid fully or fairly for their labour because
the capitalists siphon off surplus value, which they call profit. Thus, the bourgeois owners
of the means of production amass enormous wealth, while the proletariat falls further into
poverty.
Revolution and communism

Marx believed that capitalism is a volatile economic system that will suffer a series of
ever-worsening crises—recessions and depressions—that will produce greater
unemployment, lower wages, and increasing misery among the industrial proletariat.

These crises will convince the proletariat that its interests as a class are implacably
opposed to those of the ruling bourgeoisie. Armed with revolutionary class
consciousness, the proletariat will seize the major means of production along with the
institutions of state power—police, courts, prisons, and so on—and establish a socialist
state that Marx called “the revolutionary dictatorship of the proletariat.

The proletariat will thus rule in its own class interest, as the bourgeoisie did before, in
order to prevent a counterrevolution by the displaced bourgeoisie. Once this threat
disappears, however, the need for the state will also disappear. Thus, the interim state
will wither away and be replaced by a classless communist society.
 COMMUNISM IN RUSSIA

Russia in the early 20th century was an unlikely setting for the proletarian revolution that
Marx had predicted.

Its economy was primarily agricultural, its factories were few and inefficient, and its
industrial proletariat was small. Most Russians were peasants who farmed land owned
by wealthy nobles. Russia, in short, was nearer feudalism than capitalism.

There was, however, growing discontent in the countryside, and Lenin’s Russian Social-
Democratic Workers’ Party saw an opportunity to harness that discontent to overthrow
the autocratic tsarist regime and replace it with a radically different economic and political
system.

Lenin was the chief architect of this plan. As head of the revolutionary Bolshevik faction
of the party, Lenin made two important changes to the theory and practice of communism
as Marx had envisioned it—changes so significant that the party’s ideology was later
renamed Marxism-Leninism.

The first, set out in What Is to Be Done? (1902), was that revolution could not and should
not be made spontaneously by the proletariat, as Marx had expected, but had to be made
by workers and peasants led by an elite “vanguard” party composed of radicalized middle-
class intellectuals like himself.

Secretive, tightly organized, and highly disciplined, the communist party would educate,
guide, and direct the masses. This was necessary, Lenin claimed, because the masses,
suffering from false consciousness and unable to discern their true interests, could not be
trusted to govern themselves.

A second and closely related change appears in Lenin’s Imperialism, the Highest
Stage of Capitalism (1916), in which he implied that communist revolution would not
begin in advanced capitalist countries such as Germany and Britain because workers
there were imbued with reform-minded “trade-union consciousness” instead of
revolutionary class consciousness.
This, he argued, was because the most direct and brutal exploitation of workers had
shifted to the colonies of imperialist nations such as Britain. The capitalists reaped
“superprofits” from the cheap raw materials and labour available in these colonies and
were thus able to “bribe” workers at home with slightly higher wages, a shorter workweek,
and other reforms.

So, contrary to Marx’s expectations, communist revolution would begin in economically

backward countries, such as Russia, and in the oppressed and exploited colonial
countries of the capitalist periphery, later to be called the Third World.
 CAPITALISM

What Is Capitalism?
Capitalism is an economic system in which private individuals or businesses
own capital goods. The production of goods and services is based on supply
and demand in the general market—known as a market economy—rather than
through central planning—known as a planned economy or command
economy.

The purest form of capitalism is free market or laissez-faire capitalism*. Here,

private individuals are unrestrained. They may determine where to invest, what
to produce or sell, and at which prices to exchange goods and services. The
laissez-faire marketplace operates without checks or controls.

**Laissez-faire is an economic theory from the 18th century that opposed

any government intervention in business affairs. The driving principle
behind laissez-faire, a French term that translates to "leave alone"
(literally, "let you do"),

Today, most countries practice a mixed capitalist system that includes some
degree of government regulation of business and ownership of selected
industries.

History of Capitalism
➢ Although the continuous development of capitalism as a system date
only from the 16th century, antecedents of capitalist institutions existed
in the ancient world, and flourishing pockets of capitalism were present
in Europe during the later Middle Ages.

➢ The development of capitalism was spearheaded by the growth of the

English cloth industry during the 16th, 17th, and 18th centuries.

➢ The feature of this development that distinguished capitalism from

previous systems was the use of accumulated capital to enlarge
productive capacity rather than to invest in economically unproductive
 enterprises, such as pyramids and cathedrals. This characteristic was
encouraged by several historical events.

➢ Another contributing factor was the increase in Europe’s supply of

precious metals and the resulting inflation in prices. Wages did not rise
as fast as prices in this period, and the main beneficiaries of the inflation
were the capitalists.

➢ The early capitalists (1500–1750) also enjoyed the benefits of the rise of
strong national states during the mercantilist era.

➢ Beginning in the 18th century in England, the focus of capitalist

development shifted from commerce to industry.

➢ The steady capital accumulation of the preceding centuries was invested

in the practical application of technical knowledge during the Industrial
Revolution.

➢ The ideology of classical capitalism was expressed, by the Scottish

economist and philosopher Adam Smith, which recommended leaving
economic decisions to the free play of self-regulating market forces.

➢ The policies of 19th-century political liberalism included free trade, sound

money (the gold standard), balanced budgets, and minimum levels of
poor relief.

➢ The growth of industrial capitalism and the development of the factory

system in the 19th century also created a vast new class of industrial
workers whose generally miserable working and living conditions
inspired the revolutionary philosophy of Karl Marx.

➢ World War I marked a turning point in the development of capitalism.

After the war, international markets shrank, the gold standard was
abandoned in favour of managed national currencies, banking
hegemony passed from Europe to the United States, and trade barriers
multiplied.
 CAPITALISM

Features of Capitalism

Private Property and Freedom of ownership: A capitalist economy is always having

the institution of private property. An individual can accumulate property and use it
according to his will. Government protects the right to property. After the death of every
person his property goes to his successors.

Price Mechanism: This type of economy has a freely working price mechanism to guide
consumers. Price mechanism means the free working of the supply and demand forces
without any intervention. Producers are also helped by the price mechanism in-deciding
what to produce, how much to produce, when to produce and where to produce.

Profit Motive: In this economy the desire to earn profit is the most important inducement
for economic activity. All entrepreneurs try to start those industries or occupations in
which they hope to earn the highest profit. Such industries as are expected to go under a
loss are abandoned.

Competition and Co-operation Goes Side by Side: A capitalist economy is

characterized by free competition because entrepreneurs compete for getting the highest
profit. On the other side buyers also compete for purchasing goods and services. Workers
compete among themselves as well as with machines for taking up a particular work

Freedom of Enterprise, Occupation and Control: Every person is free to start any
enterprise of his choice. People can follow occupations of their ability and taste.
Moreover, there is the freedom of entering into contract. Employers may contract with
trade unions, suppliers with a firm and one firm with another.

Consumer’s Sovereignty: In a capitalist economy a consumer is compared to a

sovereign king. The whole production frame works according to his directions.
Consumer’s tastes govern the whole production line because entrepreneurs have to sell
their production. If a particular type of production is to the liking of consumers, the
producer gets high profits.

De-Merits of Capitalism:

Inequality of Distribution of Wealth and Income: The system of private property acts
as a means of increasing inequalities of income among different classes. Those who have
wealth can obtain resources and start big enterprises. The property less classes have
only their labour to offer. Profits and rents are high. Wages are much lower. Thus, the
property holders obtain a major share of national income.

Social Costs are Very High: A capitalist economy industrialises and develops but the
social costs of the same are very heavy. Factory owners running after private profit do
not care for the people affected by their production. The environment is polluted because
factory wastes are not properly disposed of.

Instability of the Capital Economy: A capitalist economy is inherently unstable. There

is recurring business cycle. Sometimes there is a slump in economic activity. Prices fall,
factories close down, workers are rendered unemployed. At other times business is brisk,
prices rise, fast, there is a good deal of speculative activity. These alternating periods of
recession and boom lead to a good deal of wastage of resources.

Working Class does not have Adequate Social Security: In a capitalist economy, the
working class does not have adequate social security, commodity, the factory owners do
not provide for any pension, accident benefits or relief to the families of those who die in
employment. As a result, widows and children have to undergo a good deal of suffering.

Slow and Unbalanced Growth: A free market economy may work automatically but the
rate of growth is rather slow. Moreover as the economy progresses, there is no all round
development. Some areas develop much faster while others remain backward. In-dustries
may expand fast while there may be poverty in agriculture.
Growth of Monopolies with their Evils: A capitalist economy is competitive only in
theory. In practice, the few competitors often arrive at an understanding and exploit the
consumer. Sometimes the bigger firms buy or eliminate the smaller firms to establish their
supremacy in particular lines or production. They charge high prices and do not have any
compulsion to improve efficiency of production.

Unemployment and Under-employment: A capitalist economy has always some

unemployment because the market mechanism is slow to adjust to the changing
conditions. Business fluctuations also result in a large part of the labour force going
unemployed during depressions. Not only this, workers are not able to get full time
employment except under boom conditions.
 RUSSIAN REVOLUTION

The Russian Revolution of 1917 came about in a way that no one, not even Lenin, had
predicted. Its immediate impetus was World War I, which was taking a heavy toll on
Russian soldiers at the front and on peasants at home.

Riots broke out in several Russian cities. When Tsar Nicholas II ordered soldiers to put
them down, they refused. Nicholas abdicated, and his government was replaced by one
led by Aleksandr Kerensky. Committed to continuing the war against Germany,
Kerensky’s provisional government was almost as unpopular as the tsar’s.

Lenin returned to Russia from exile in Switzerland barely in time to lead the Bolsheviks in
seizing state power in October (November, New Style) 1917. He then became premier of
a new government based on soviets, or workers’ councils.

The Soviet government moved quickly to withdraw from the war in Europe and to
nationalize private industry and agriculture. In the name of the people and under the
banner of War Communism, it seized mines, mills, factories, and the estates of wealthy
landowners, which it redistributed to peasants.

The landowners and aristocrats, aided by troops and supplies from capitalist countries,
including Britain and the United States, mounted a “White” counterrevolution against the
“Red” government.

The Russian Civil War ended in 1920 with the victory of the Reds, but the war in Europe
and the war at home left the Soviet Union in shambles, its economic productivity meagre
and its people hungry and discontented.

Desperate for room to maneuver, Lenin in 1921 announced the New Economic Policy
(NEP), whereby the state retained control of large industries but encouraged individual
initiative, private enterprise, and the profit motive among farmers and owners of small
businesses.
Lenin’s death in 1924 left Joseph Stalin, Leon Trotsky, and Nikolay Bukharin as the
leaders of the All-Russian Communist Party. Before he died, Lenin warned his party
comrades to beware of Stalin’s ambitions. The warning proved prophetic.

Ruthless and cunning, Stalin—seemed intent on living up to his revolutionary surname

(which means “man of steel”). In the late 1920s, Stalin began to consolidate his power by
intimidating and discrediting his rivals.

In the mid-1930s, claiming to see spies and saboteurs everywhere, he purged the party
and the general populace, exiling dissidents to Siberia or summarily executing them after
staged show trials. Bukharin was convicted on trumped-up charges and was executed in
1938. Trotsky, who had fled abroad, was condemned in absentia and was assassinated
in Mexico in 1940 by one of Stalin’s agents. Those who remained lived in fear of the
NKVD (a forerunner of the KGB), Stalin’s secret police.