Economic Systems

The three basic economic problems and how different socities solve

them
Every society has to face the problem of how to organize social production in order to survive.
• WHAT should be produced and in what quantities, given the scarce resources? How much bread,
and how much milk? How many computers? How many hair-cuts? This has to be decided for all
economic goods and services.

• HOW should things be produced? There are many ways of producing things and there are different
combinations of resources that may be used in production. People will make their own clothes, or
will get them elsewhere? Should cars be produced by robots or by manual workers?

• FOR WHOM should things be produced? Who should get them? Should they go to those who can
pay for them or be shared out in some “fair” manner? How will the total production or wealth be
distributed among people? Who will get more? Who will get less?

Whatever the system used to allocate resources, it needs to be able to answer these questions.
Economic systems are defined either by the way stuff is produced or
by how that stuff is allocated to people.
Through time, societies answered this questions in different ways. The ways in which different
societies decide what, how much, how and for whom to produce define different economic
systems.
FUNDAMENTAL ECONOMIC SYSTEMS
QUESTIONS TRADITIONAL
COMMAND
MARKET
"MIXED"
(primitive agrarian,
(Socialism,
(Capitalism)
(Capitalism)
slavery, feudalism)
Communism)
What to produce? Determined by State-Governme Determined by A combination of
(What kinds of goods tradition and religion nt or different consumer's choices private enterprise
and services should ("we do what our central planners ("money votes"). working through the
be produced?) parents did before (based on No government marketplace and
us"/ people’s needs) intervention. government regulation.
"we follow God's will")
How to produce? Determined by State-Governme Determined by the A combination of
(What productive tradition and religion nt or different competition private enterprise
resources are used ("we do what our central planners between working through the
to produce goods parents did before (“from top to producers marketplace and
and us"/ bottom”) (“competition government regulation.
 services?) "we follow God's will") breeds
innovation”)

For whom to Determined by State-Governme Based on people's A combination of

produce? (Who gets tradition and religion nt or different wealth/income private enterprise
to have the goods ("we do what our central planners ("you can only get working through the
and services?) parents did before (based on things if you have marketplace and
us"/ people’s needs) the money to pay for government regulation.
"we follow God's will") them")

Traditional Economic Systems

In primitive agrarian societies, the entire family or tribe produced all that they needed to fulfill
their needs and wants, all by themselves. Family members would build their own houses, grow their
own vegetables, hunt their own animals, make their own clothes, bake their own bread, etc., all with
rather simple methods of production, only enough for subsistance. This economic system is
self-sufficient and involved very little exchange with other family or tribe members, mainly through
bartering. Everybody worked to satisfy the needs of the community as a whole, and there was no such
thing as a government nor private property. Economic activity was driven by tradition and religion:
They produced, distributed and consume the products of their work in the same way their predecessors
did, as if it was the natural or divine order of things.
Today, this kind of traditional economy is limited to specific rural areas and indigenous communities.
Later, societies got wealthier and more complex, and private property emerged. Some
people began to own the resources needed to produce (means of production), and even other
people. With private property, social classes also appeared. In ancient Greece, slaves
produced most of the goods that the whole society needed. Slaves were individuals who
lacked personal freedom or rights and existed as the property of their owner (the citizens,
“free people”). They did all the work to sustain their lives and the lives of their owners, that
did not work (slavery). During the Middle Ages in Western Europe, the lords owned all the
lands and leased them out to peasants. Peasants lived in the land and used it to farm food and
were obliged to hand over most of their production to their lord. In return, the lord offered
the peasants relative safety and security from invasions (feudalism). One social class (slaves,
peasants) worked to satisfy the needs of everybody, including those who didn’t work (citizens,
lords), because those who didn’t work owned the resources needed to make everything.

In all these kinds of economic systems (primitive agrarian, slavery, feudalism), what is
produced is based on tradition and the habit of how such decisions were made in the past.
 Market Economy or Capitalism

In capitalism, capitalists own the means of production, including the tools used for
production and the finished products. Workers are hired in return for wages, and the
worker owns neither the tools he uses in the production process nor the finished product
when it is complete. If you work at a shoe factory and you take home a pair of shoes at
the end of the day, that’s stealing, because they are the private property of the capitalist.
If you want them, you must buy them in a market with money. A market is where buyers
and sellers come together to trade goods and services.

Companies, owned by capitalists, produce goods and services for sale in order to
make a profit, not for personal consumption. Capitalism is a market economy: Capitalist
production relies on the market for the allocation and distribution of the goods that are
produced for sale. It even has an specific labor market where people's working time is
bought and sold as any other good or service.
 Who is responsible for making the decisions in a market economy? Unlike other economic systems, no
single individual or organization or government is responsible for solving the economic problems in a market
economy. Instead, millions of businesses and consumers engage in voluntary trade, intending to improve their
own economic situations, and their actions are invisibly coordinated by a system of prices and markets.

What goods and services will be produced is determined by the “money” votes of consumers in their daily
purchase decisions. A century ago, many “votes” (purchases) for transportation went for horses; today, much is
spent on cars. Companies, in turn, are motivated by the desire to maximize profits. Firms abandon areas where
they are losing profits, and dive into production of goods in high demand that promise high profits.

How things are produced is determined by the competition among different producers. Producers try to keep
costs at a minimum by adopting the most efficient methods of production in order to “stay in the game” (sell
their commodities).

For whom things are produced—who is consuming and how much—depends, in large part, on the distribution
of income between the population. In a system based on trade and profit, the more income and wealth you
have, the more important your opinion is, regarding this issue. In principle, your needs only count if you can pay
to satisfy them in a market.
 Command Economy or Planned Economic System

Alternatives to capitalist production existed and exist even today. The most significant ones developed in
the 19th century as a response to what was seen as capitalism's abuses. The planned economic system or
command economy is sometimes called the socialist economic system, and it usually associated with a
communist political system that aims for social equality. In the past, China and the former Soviet Union were
often used as the best examples of planned economies, because the vast majority of the means of production
and economic activities were owned and controlled by the State. North Korea and Cuba planned economic
systems persist today.

In planned economies, production decisions (what, how and for whom production should take place) are
decided by the government or other central planners (as workers’ cooperatives). Resources are also
controlled by the government on behalf of its citizens, and there is no private businesses.
A planned economic system enables basic needs (access to education, healthcare and employment) to be
fulfilled by everyone in society, regardless of its people’s income, and there is also less inequality in this matter.
The “Mixed” Economy
In reality, pure “free-market” economy, without government intervention of any kind, doesn’t exist. It’s only a
theoretical construct. In every capitalist country driven by private initiative there is also a national State with a
government. Therefore, the economy of almost every country in the world is a mixed economy: a combination of
private enterprise working through the marketplace and government regulation.
Governments have three main economic functions in a market economy:
1. To increase efficiency, promoting competition, limiting market externalities, and providing public goods.
2. To promote equity by using tax and expenditure programs to redistribute income toward particular
groups. 3. To foment macroeconomic stability and growth, reducing unemployment and inflation while
encouraging economic growth through fiscal and monetary policy.

“An efficient and humane society requires both halves of the mixed system—market and government.
Operating a modern economy without both is like trying to clap with one hand”.
Paul Samuelson, 1970’s Nobel Prize in Economic Sciences winner, father of the “Neoclasssical synthesis”.