The economic systems which have been adopted to deal with these economic problems differ from country to country; each has its own particular features. Nevertheless, some of the systems are very similar to one another, and they can be classified into three or four groups.
In this type of economy, people live according to age-old customs. What is to be produced, and how it is to be produced and shared out, are not seen as economic problems, because these things have all been decided long ago. These economies are often described as subsistence economies because goods have been produced little more than the minimum necessary for survival
Market economies or Capitalism
Capitalism is that economic system in which the means of production are owned and managed by private individuals. Self –interest and profit motive are the guiding principles of this system. The central problems in a capitalist economy are solved by the price mechanism. Price mechanism works through the interaction of the forces of demand and supply
The institution of private property is a major feature of a market economy. It means that individuals have the right to own, control and dispose of land, buildings, machinery and other natural and man-made recourses.
Under this system individuals are free to set up in business themselves, firms are free to decide what and how they should produce, workers are free to enter and leave occupations, and consumers are free to spend their income as they wish. The system encourage people to do what is best for them
The merits of market economy are:
a) Automatic function through price mechanism
b) Higher efficiency and incentive for hard work: – The person who takes the initiative and extraordinary is amply rewarded .The society gets the service of the most efficient producers. The cost of production and price automatically come down to the benefit of all.
c) Higher rate of capital formation
d) Optimum utilisation of resources: – Under market economy producers spend large amounts of money on research and development .This leads to invention and innovations and world at large gains from them.
e) Encouragement to enterprise and risk taking:- Foreign investment may be encouraged since overseas producers may expect a higher return on their investment and less fearful of government intervention.
f) Economic development and prosperity
Demerits of market economy
a) Wasteful competition:-Very often the nation’s scarce recourses are wasted and depleted in unnecessary competition. Recourses are misallocated and wasted. More luxury goods are produced in place of necessaries of life.
b) Human welfare ignored:-The profit motive leads to the production of goods and services which may be harmful to society. It emphasise profits rather than human welfare.
c) Economic instability and economic inequality:-This system leads to inequality of income and wealth. These will create social and economic disturbance in the economy.
d) Class conflict: – There is a conflict between have and have not.
e) Develops monopoly: – Monopolies have the power to raise the price well above the cost of production and may be inefficient. By preventing other firms from entering the industry, they restrict consumers’ choice.
f) Certain non-market services may not be provided e.g.:- law and order, defence etc.
Public Expenditure and market economy
(Q.Why might public expenditure fall if an economy comes to rely more on the market system?)
Under the market economic system price mechanism solved the problems of recourses allocation, without government intervention. Therefore if an economy close to market economic system, the role of government will be significantly reduced and public sector will become less important in allocating res .As a result public expenditure might fall and private expenditure might rise
Command economy or socialism
Command economy is an economic system in which means of production are owned by the state and operated by the government or community and in which production is based on the welfare of the community and not for the profit motive. In a socialist economy, decisions are taken by the central planning authority. The central problems are solved through the mechanism of planning
- Means of production are controlled and owned by the state.
- Public welfare is the motto of a command economy. Resources are allocated to industries by Govt. directives. In this type of economy; resourses are directed to different uses by the govt.
- Command economy aims at elimination of competition.
- Central planning authority regulates everything
- In a command economy prices are not free to change in response to changes in supply and demand.
- Equal distribution of income and wealth among people.
- Govt. has major role in a command economy .Everything is run by the Govt.
- For the welfare of the people a govt. Provides all public goods
The demerits of command economy are:
a) Loss of consumer’s sovereignty
b) Loss of economic freedom
c) Loss of personal liability
d) Lack of incentive
e) Too much power concentrated in the state
Government to act as a producer of goods or service
Where there is the market system failure to produce some goods and service there will be the government act as a producer of goods and service .There are some goods that private sector has no interest to produce because nobody is willing to pay for them. Such goods like street light are therefore produced by government, financing them through taxation. It might also be desirable for a government to act as a producer of merit goods such as education and healthcare .Moreover, natural monopolies, such as railway, electricity may be run by the government. This may prevent the consumers being exploited by a private sector and avoid the congestion on environment. Also government take the control over the production of nuclear energy, defence etc
Mixed economy is an economic system in which public sector and private sector exist side by side and operate for the welfare of the economy .In mixed economy there will be a combination of price mechanism and planning to solve central economic problems.
- In mixed economy the growth rate is more as both private and public sectors produce more goods with competitive spirit.
- A mixed economy based on democratic principles. It promotes economic, political, civil and cultural freedom of the people. There is also freedom of occupation, press and speech which are not found in a completely command economy or completely market economy.
- In a mixed economy commodities are produced according to the tastes of the consumers.
- Private sector is guided by the profit motive where as public sector is guided by service motive. Some industries will be under joint ownership of private individuals and the Govt.
- Govt will control and supervise the private sector by way of price policy, tax policy etc.
- People have the right of private property and right of inheritance
- In a mixed economy social costs are controlled by the Govt. And there will be steady economic growth.
Why most countries have decided to have a mixed economy?
A mixed economy seeks to gain advantages of both a market and a planned economy whilst avoiding their disadvantages. In a mixed economy, the government finance for the production of merit goods such as education, health care, law and order etc.Similarly government discourage the production and consumption for demerits goods like drugs and alcohol by imposing high taxes and license. Government also take into account of social cost and benefits to maximise social welfare. On the other hand, private sectors take imitative to new inventions, technological development and new production technique. These will widen consumers’ choice and boost up economic development. Therefore, most economies have decided to have a mixed economy so that the presence of both a public and private sector will allow the economy to reap benefits from the ‘best of both worlds’
Merits goods and demerits goods
Merits goods are those goods which the government thinks everyone should to have. The best examples are education and health services. Many governments supply these services to everyone, regardless of their level of income. Other examples of merits goods are public libraries, personal social services and the road network.
The product which the government regards as harmful and which will be over consumed if left to market forces are known as demerit goods. e.g.:- tobacco, alcohol, drugs, etc.
Public goods and services
This term refers to goods and services which would not be supplied in a market economy because it is not possible to charge a person for the amount he or she consumes. For examples, street light, police force, light house, weather forecasts etc. The payment for these services must be financed from taxation.
Social costs and benefits
Social cost is the total cost to society of the production or consumption of a product which is not paid for by those people or firms who create it. Examples of social costs are air pollution, smoke, water pollution etc
Social cost = private cost+ external cost or negative externalities
An external cost occurs when an economic activity incidentally does harm to others. For example, the operator of a motor cycle repair shop from which all sorts of noise the neighbourhood and for which he pays no compensation to others is said to produce an external cost.
If there is an increase in water pollution and air pollution, the result is increasing health problems. The government has to provide more health services. It has to raise public expenditure. To cover this money what to spend for the health services, the government has to impose extra taxes. This means the whole society will be paid for external cost.
Social benefit is the total benefit to society from an economic activity. It consists of private benefit plus positive externalities (external benefit).For example; a government had launched a family planning program to control population growth. This government action has more social benefits like:-
I. Increase in living standard
II. Decrease in unemployment
III. Favourable distribution of income
IV. Better education and health facilities and so on