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Economic System

Updated on April 30, 2024
Article byPrakhar Gajendrakar
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is An Economic System?

The economic system refers to the system of economic processes like production, consumption, and investment prevailing in a geographical location. The role and significance of the participants like government and private entities vary with the types of the economic system.

What Is Economic System

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Answers to questions, like what to produce, how to produce, when to produce, how it is distributed, and which entity controls the economic processes, help understand and interpret the design of an economic system. For example, in capitalism dominated by the free market, prices, and production decisions are greatly controlled by private entities, and government intervention is minimal.

Key Takeaways

  • Economic systems refer to the framework the nation and its people follow to manage economic processes. It determines how activities like production, distribution, and resource allocations happen in a geographical area.
  • The main types observed worldwide are – traditional, command, mixed, and market economies.
  • Identifying the system followed by a region discloses how it operates within and outside its border regarding trade, income, tax rules, and growth.
  • Examples: Bhutan is more inclined toward a traditional economic structure, North Korea reflects a command economy, Japan is a market economy, and the United States promotes a mixed economic framework.

Economic System Explained

The economic system functions to assess the resource requirements of a region or nation and takes care of the implementation of the ways to allocate the same. This requirement depends on the production, distribution, and consumption of the goods and products in an economy. The arrangement revolves around four determinants – what, how much, and how to produce along with the fourth parameter of whom to distribute. Understanding these four aspects makes the economic system definition even clearer.

What to produce makes the system focus on the products and services that are more frequently used and consumed in a region or country. Based on what is consumed more, the system determines the product, the production of which is prioritized. The second is how much to produce. This is determined by a product’s market demand. If there is demand for something, it must be manufactured or produced in significant volume, else the production comes to halt or follows a demand-based pace.

Next is how to produce, which includes all resources to be used for the production from labor to capital. While the other two are decided by the policies that the government introduces, the choice of equipment and methods for production are determined by the firms that produce the items. The last on the list is whom to distribute. It is determined based on the income range one falls into. If a product is meant and priced for people with higher income, the same would be distributed to such consumers, and the items produced for those with a lower income are aimed and distributed to the concerned portion of the population only.

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Types

There are different economic system types. Let us look into a brief description of the following to understand the characteristics of these systems that exist in the market:

Economic System Types

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Traditional Economic System

It is based on and gives significance to the customs and traditions of a country’s citizens. People engage in trade or barter systems for their survival, and the production, distribution, and policies are influenced by culture. It is vastly based on agriculture. The arrangement can be majorly seen in underdeveloped and developing nations. It is also known as a subsistence economy. It is also believed that every other economy involves a history of the traditional system, and if observed closely, parts of the traditional economy can still be seen in them.

In a traditional economyTraditional EconomyA traditional economy is a system where goods production and distribution are driven by time-honored beliefs, customs, culture, and traditions. read more, societies and communities follow their ancient culture and are not dominated by technological integration. It is majorly centered around local communities and families and operates through a barter exchange. They usually export agricultural products and raw materials to developed nations in exchange for finished goods.

Command Economic System

In Command economyCommand EconomyCommand economy is a system where the government decides goods production, process, quantity, and price in a country. In this system, the government even manages income and investments. Communist nations like the former Soviet Union, Cuba, North Korea work according to this system.read more, the government or a central authority plan and control the vital processes in the economy. It doesn’t entertain an economy with the potential to pave the way for competition and the free flow of ideas. It exhibits a government system making production, consumption, and investment decisions. Hence forming a monopoly owned by the government.

Market Economic System

Minimal or no government intervention and economic processes shaped by the law of supply and demand are properties of this type. There exist free competition and free flow of ideas where entities utilize all possible opportunities, promote innovations, and sell their products based on the price accepted by the consumers. Private entities can develop an appreciable level of power when functioning in this type of system. One of the examples is the individual favored capitalismCapitalismCapitalism is an economic system consisting of businesses, resources, capital goods, and labour. Private entities own it, and the income is derived by the level of production of these factors. Because of the private hands, these entities can be operated efficiently and maximize their production activity also.read more.

Mixed Economic System

A mixed economic systemMixed Economic SystemA mixed economic system is one that combines capitalist and socialist ideals. It allows for the protection of private assets while also allowing for liberty in use of capital and federal intervention in economic decisions.read more originates when a system is made of specific principles from different economic systems. It is the amalgamation of the market, traditional, and command economies. Most of the world’s economies are becoming mixed economies. It is perfect when countries advocate for globalization. A country can identify global opportunities, export what it does best, and import what other countries produce best.

In a mixed economy, the private sector booms because the laws encourage it. Every citizen is allowed to live and earn freely. The law of supply and demand contributes significantly to the price determination process. Simultaneously, the government can implement control measures like price ceilings to protect consumers.

Examples

China: It is one of the popular examples of a socialist market economy but not a pure socialist economy. There are private companies in China, but the government has a predominant role in the economy. They plan, manage and exercise direct control over the national economy.

Belarus: It is a country in Eastern Europe. Even if they state their system as market socialism, the framework resembles the properties of a command economic system where the central government owns most of the businesses and banks and controls the production and distribution of goods. Of course, there are reforms and deregulations, but still, the public sector dominates the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more, and government intervention is significant.

United States: United States has a mixed economy as it encourages free market and government intervention for the public good. Hence, reflecting the characteristics of capitalism and socialism.

Advantages & Disadvantages

The advantages and disadvantages of each economic system have been mentioned below:

Advantages

  • In a traditional economic system, the citizens follow existing traditions and know what is expected from them and how they must work. Individuals, here, have to continue with the traditions that have long been followed, be it deciding the products to manufacture or labor and capital to put to use.
  • The command system believes in changing directions for better profits. Hence, they might be a small agriculture unit at one point and become a major industrial ace at another point, and that too, in a short span of time.
  • A market economic system is adaptive. It prefers changing based on the transforming scenarios and situations around it. Decision-making in this type of arrangement is decentralized and hence, participation from the majority of the population is encouraged. In this type, the interference from the government is limited, and individuals have a greater level of freedom.
  • This is a hybrid arrangement, which enjoys one or the other benefits of all other systems operating in the market. This arrangement allows private firms to operate efficiently with the least intervention from the government. The government here is only to formulate effective programs from time to time.

Disadvantages

  • The traditional system has one major defect and that is its resistance to change. It refrains from new ideas and sticks to old ideals.
  • The command system is not for consumers. It accepts and rejects directions based on what’s trending. This arrangement does not have any incentive program or other schemes for people working hard.
  • In a market economy, government intervention is quite important as the arrangement is such that it does not always emphasize the basic needs of the population.
  • Unbalanced government intervention, i.e., the administration is either extremely involved or not involved at all, is the disadvantage of having a mixed economic arrangement.

Frequently Asked Questions (FAQs)

What are the four main types of economic systems?

The four main types are the following:
Traditional: Customs and traditions exert great influence
Command: Government has direct control over the national economy
Market: Private entities have significant power, free market, free flow of ideas, and minimal government intervention
Mixed: Mix of other systems

What are examples of economic systems?

The nation or areas significantly reflecting the properties of the traditional economy are Bhutan, central African Mbuti, the Australian Aborigines, and the Inuit of Northern Canada. Examples of command economies are East Germany and North Korea. England and Japan are examples of market economies. France and the United States have mixed economies.

What is the economic system in the United States?

The United States is one of the top countries containing a capitalist economy. However, the structure is an example of a mixed economy because encouragement for a free market and government intervention for public good exists concurrently. Hence, reflecting the elements of capitalism promoting free market and socialism encouraging fair government participation.

This has been a guide to what is Economic System. Here we explain its types along with examples and advantages and disadvantages of each of them. You can learn more from the following articles –

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Comments

  1. Melinda Kandi says

    This article is very helpfu.It gives clear,simple and precise information which helps a lot.

  2. Melinda Kandi says

    This article is very helpful as it has simple, clear and precise information which helps a lot.

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