Economic Systems

Now we understand the basic economic problem, we can look into more detail at the systems used to try and answer the questions posed by the basic economic problem. We will look at these different systems based on the following three areas:

Resource Ownership - That is, who owns the resources within the system.
Economic Decision Making - That is, who makes the decisions within the system. Individuals v a central entity
Rationing System - That is, how are resources divided amongst the people within the system.

And then based on the answers to the above, we can characterise the economic systems as:

Planned Economy
Mixed Market Economies
Free Market Economies

Resource Ownership

Resources can be owned by either the private sector or public sector.

The private sector refers to resources owned by private individuals or groups such as households and firms (including for profit organisations, NGOs and interest groups (unions, consumer groups etc).

The public sector refers to resources owned by either local, regional or national governments.

Planned Economies have higher levels of public sector ownerships whereas Free Market Economies have private sector resource ownership.

Rationing System

Rationing systems refer to how scarce resources are divided amongst its interested users. In economics, it refers to the method used to determine resource allocation and output/income distribution decisions.

In free market economies, prices are used to determine how we allocate our scarce resources and to address the questions how to produce, what to produce and for whom to produce for.

In planned economies non price methods are used to allocated resources. Non price rationing is used in the absence of markets and usually involve a central power or authority determining what is produced, who is it produced for and how is it produced.

Economic Decision Making

Economic decisions and choices regarding the basic economic questions of what to produce, how to produce and for whom to produce for can be made by either the public sector (governments) or private sector (firms).

Planned Economies economic decision making tends to be made by governments, whereas Free Market Economies economic decision making tend to be made by the private sector.

Advantages of each Economic System

Mixed Market Economies

As we will see as we progress through the course, no country in the world is either a pure Free Market Economy nor a fully Planned Economy. Most countries do have a mix of the above and the degree in which they do is often dictated by political ideologies. Therefore, most countries fall along the spectrum. However, Government involvement in economies is not just limited to resource allocation. Government involvement can also be through policy and other actions that can impact the free markets ability to operate. For example, the US is more towards the free market economy, however it still have some government intervention in certain markets, such as minimum wage or trade policies such as tariffs & quotas. This intervention changes the outcomes in these markets regarding the resource allocation, and we will look at this in more detail as the course progresses.

Therefore in mixed market economies both price rationing and non price rationing are observed. In areas where markets operate, price rationing can be observed such as those for certain goods and services or resources. In other areas, such as national defence or government provided healthcare, then we can observe non price rationing in governments determining what to produce and what resources to allocate to the particular area.

The Function of Money in an Economic System

Money plays a vital role in any modern economy because it overcomes the limitations of a barter system. In barter, trade can only occur when there is a double coincidence of wants, meaning each party must have something the other desires at the same time. Money solves this problem by acting as a medium of exchange. Individuals and firms are willing to accept money in return for goods and services because they are confident others will also accept it later. This makes transactions smoother, quicker, and more efficient, enabling greater specialisation and trade.

Beyond being a medium of exchange, money also serves as a unit of account, a store of value, and a standard of deferred payment. As a unit of account, it provides a common measure for valuing goods and services, making price comparisons straightforward. As a store of value, money allows people to transfer purchasing power over time, provided inflation is not too high. Finally, as a standard of deferred payment, money makes it possible to borrow and lend, or enter into contracts involving future payments, with confidence that obligations can be settled. Together, these functions explain why money is central to economic activity and why trust in the stability of money is so crucial for the functioning of markets.

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