Economic

System
Economic System
and it’s Functions
The Economy’s Working
Parts
 Objectives:
At the end of the session, students should be able to:

• discuss what is economic system;

• identify the functions of

economic system;

• learn the economy’s working parts.

 Economic System and it’s Functions

Economic System
- is a system of production and exchange of goods and
services as well as allocation of resources in a society.
- it includes the combination of various institutions,
agencies, entities and consumers that comprise the economic
structure of a given community.
 Economic System and it’s Functions

Types of Economic System:

1. Traditional Economic System

2. Command Economic System

3. Market Economic System

4. Mixed Economic System

 Economic System and it’s Functions

Functions of Economic System:

1. What to produce

2. How much to produce

3. For whom to produce

4. How to distribute resources

 Economic System and it’s Functions

• What to produce
- the very first problem of economic system, economic
resources which produce goods and services are generally
speaking not abundant in spite to the duty of the government
to see that the economy run as smooth as possible. Therefore,
it is to see that goods and services and produced in
accordance with the availability of resources and in what
quantity and thus, allocation of resources depends upon the
administration.
 Economic System and it’s Functions

• How much to produce

- the function is to take decision how goods and services are
to be produced. The main issue is the choice of techniques for
the allocation of resources to produce goods and services in the
most economical way. This ensures the lowest possible cost of
production and at the same time output minimizes cost and
maximizes output.
 Economic System and it’s Functions
• For whom to produce
- here the function of an economic system is to decide
about the distribution of goods and services produced in their
final form in one year and this ma be determined through
needs of individuals this usually leads to an equal
distribution of wealth, otherwise it will not.
- distribution of wealth also refers as to how much
proportion of wealth is to be in the hands of private
entrepreneurs or otherwise government bears the whole task
of ensuring suitable distribution of wealth.
 Economic System and it’s Functions

• How to distribute resources

- one of the function of economic system, here we see that
through an economic system the humans and natural resources
are distributed among different occupations according to the
economic needs of the society. Thus age group of the working
class must be determined in accordance with the composition of
population.
 Economic System and it’s Functions
-The people talent and aptitude should determine the
suitability of their profession to maximize utilization of
resources. Distribution of resources also shoes covers
the aspect of aggregate saving and aggregate investment
in different sectors of the economy with a view to
achieve full employment in the short period possible.
 Economy’s
Working Parts
 Economy’s Working Parts

Economy’s Working Parts

Decision Makers Coordination Mechanism

 Economy’s Working Parts
• Decision Makers
The decision maker of an economy is any person organized
group of persons that makes choices. Decision makers fall into
three groups.
1.Households
A household is any group of people living together as a
decision making unit. Every individual in an economy belongs
to a household. Households supply factors of production to
firms and governments. Factors of production are economy’s
productive resources usually classified under three headings.
 Economy’s Working Parts
a. Labour
It refers to the brain power and physical power of human beings.
b. Land
It refers to natural resources of all kinds.
c. Capital
It refers to man made means of production. It includes machines,
buildings, tools, and other manufactured goods that can be used in
production.
 Economy’s Working Parts

Households sell or rent factors of production to firm and

governments and receive an income in payment for their supply.
Households also receives benefits from the government and pay
taxes to the government, with what is left households buy goods
and services produced by firms.
 Economy’s Working Parts
2. Firm
A firm is an organization that produces goods and services to
earn profits. All producers are called firms. Firms hire factors of
production from households and choose how to use them to
produce goods and services. They also decide what goods and
services to produce and in what quantities.
Expenditures by households and governments on goods and
services are received by firms. Firms use these receipts to make
payments to household for the production supplied. Firms also
receive subsidies and pay taxes to governments.
 Economy’s Working Parts
3. Government
A government is an organization that has two functions: the
provision of goods and services to households and firms and
redistribution of income and wealth. Examples of the goods and
services supplied by government are national defense, law
enforcement, public health, transportation and education.
Governments decide on the scale of purchases of factors of
production from households and of goods and services from
firms. They also decide on the scale of provision of goods and
services to households and firms, as well as on the rates of
benefits and subsidies and taxes.
 Economy’s Working Parts

• Coordination Mechanism
The most striking thing about the choices made by
households, firms and governments is that they must come
into contact with each other. For example, households
choose the types and quantities of labor to sell and firms
choose the types and quantities of labor to buy. Similarly in
markets for goods and services households choose the types
and quantities of goods and services to buy, while firms
choose the type and quantities to sell.
 Economy’s Working Parts
There are two mechanism that can achieve a coordination of
individual economic choices:
1. Market Mechanism
A market mechanism is a method of determining what, how
and for whom to produce, based on individual choices
coordinated through market. The market is a coordination
mechanism because it pools together that separate plans of all
the individual decision makers who try to buy and sell any
particular good. The markets coordinate individual decisions
through price adjustments.
 Economy’s Working Parts
2. Command Mechanism
A command mechanism is a method of determining what,
how, and for whom goods and services are produced based on
the authority of a central planning authority.
 Economy’s Working Parts

However, it should be noted that in actual life, in most of the modern economies, both the command
and market coordination mechanism operate simultaneously. As such these economies are referred to
as mixed economies. Indian economy is the best example of mixed economy.
Thank You
for
Listening 