Economic Systems: Definition, Types, and Characteristics

An economic system refers to the way in which different societies solve the three different basic economic problems which are: which goods should be produced and in what quantities? How should various goods and services be produced?  How should various goods and services be distributed? To answer this question, various political and economic structures have been put in place. The major economic systems include the free market system, planned economic system, and mixed economic system.

1) Free Market Economy

A free market economy refers to a system where decisions about allocation of resources are made by individuals on the basis of prices generated by forces of demand and supply.

Features/Characteristics of a Free Market System

  • Private property individuals have the right to own or dispose off their property as they may consider it fit.
  • Freedom of choice and enterprise Individuals have the right to buy or hire economic resources, organize them for production purpose and sell them in the market of their choice. Such persons are referred to as entrepreneurs.
  • Self interest in the pursuant of personal goals. The individuals are free to do as they wish and have the motive of economic activity in self-interest.
  • Competition There is a large number of buyers and sellers such that each buyer and seller accounts for but is insignificant to influence the supply and demand and hence prices.
  • Reliance on price mechanism: This is an elaborate system of commerce in which numerous choices of consumers and producers are aggregated and balanced against each other. The interaction of demand and supply determine prices.
  • No government intervention hence no price controls, taxes and subsidies.
  • There are property rights provided and enhanced by the government through copy rights patents, trademarks etc. e.g. on innovating and inventing one is protected from absorption and thus you enjoy the benefits.
  • There is excessive advertising

2) Planned Economy

A planned economy, also known as command or controlled economy, refers to an economic system where the crucial decisions are determined by a body appointed by the state. The body takes up the role of the mechanism which prevails in a free market economy.

Features of a command economy

  • Leadership and control of economies. All important means of production (resources) are publicly owned such as land, power generation, housing among others.
  • Rationing of certain commodities if supply of such fall below demand.
  • Existence of production targets for different sectors of the economy. The government determines how resources are allocated through planning.
  • Fixing of prices and wages
  • Occasional existence of restricted labor market in which workers take up jobs assigned to them.
  • Government decides what is to be produced, how it will be produced and for whom to produce

3) Mixed Economy

A mixed economy refers to an economic system where resource allocation is determined by the state, i.e. the government and price mechanism. Both the government and private sector have a role to play in resource allocation. It is widely adopted in many countries and results varied depending on nature of the economy. The government normally intervenes when the private sector of market fails to allocate resources effectively as long as the objective of the economic growth and development is achieved.

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