by An economic system is a means by which societies or governments organize and distribute available resources, services, and goods across a geographic region or country. Economic systems regulate the factors of production, including land, capital, labor, and physical resources. An economic system encompasses many institutions, agencies, entities, decision-making processes, and patterns of consumption that comprise the economic structure of a given community.
An economic system, or economic order, is a system of production, resource allocation and distribution of goods and services within a society or a given geographic area. It includes the combination of the various institutions, agencies, entities, decision-making processes and patterns of consumption that comprise the economic structure of a given community.
An economic system is a type of social system. The mode of production is a related concept. All economic systems must confront and solve the three fundamental economic problems: what kinds and quantities of goods shall be produced, What and how much economic resources will be used and how will the output be distributed?
The study of economic systems includes how these various agencies and institutions are linked to one another, how information flows between them, and the social relations within the system (including property rights and the structure of management). The analysis of economic systems traditionally focused on the dichotomies and comparisons between market economies and planned economies and on the distinctions between capitalism and socialism. Subsequently, the categorization of economic systems expanded to include other topics and models that do not conform to the traditional dichotomy.
Today the dominant form of economic organization at the world level is based on market-oriented mixed economies. An economic system can be considered a part of the social system and hierarchically equal to the law system, political system, cultural and so on. There is often a strong correlation between certain ideologies, political systems and certain economic systems (for example, consider the meanings of the term “communism”). Many economic systems overlap each other in various areas (for example, the term “mixed economy” can be argued to include elements from various systems). There are also various mutually exclusive hierarchical categorizations.
Types of Economic Systems
There are many types of economies around the world. Each has its own distinguishing characteristics, although they all share some basic features. Each economy functions based on a unique set of conditions and assumptions. Economic systems can be categorized into four main types: traditional economies, command economies, mixed economies, and market economies.
- Traditional economic system
The traditional economic system is based on goods, services, and work, all of which follow certain established trends. It relies a lot on people, and there is very little division of labor or specialization. In essence, the traditional economy is very basic and the most ancient of the four types.
Some parts of the world still function with a traditional economic system. It is commonly found in rural settings in second- and third-world nations, where economic activities are predominantly farming or other traditional income-generating activities.
There are usually very few resources to share in communities with traditional economic systems. Either few resources occur naturally in the region or access to them is restricted in some way. Thus, the traditional system, unlike the other three, lacks the potential to generate a surplus. Nevertheless, precisely because of its primitive nature, the traditional economic system is highly sustainable. In addition, due to its small output, there is very little wastage compared to the other three systems.
- Command economic system
In a command system, there is a dominant, centralized authority usually the government that controls a significant portion of the economic structure. Also known as a planned system, the command economic system is common in communist societies since production decisions are the preserve of the government.
If an economy enjoys access to many resources, chances are that it may lean towards a command economic structure. In such a case, the government comes in and exercises control over the resources. Ideally, centralized control covers valuable resources such as gold or oil. The people regulate other less important sectors of the economy, such as agriculture.
In theory, the command system works very well as long as the central authority exercises control with the general population’s best interests in mind. However, that rarely seems to be the case. Command economies are rigid compared to other systems. They react slowly to change because power is centralized. That makes them vulnerable to economic crises or emergencies, as they cannot quickly adjust to changed conditions.
- Market economic system
Market economic systems are based on the concept of free markets. In other words, there is very little government interference. The government exercises little control over resources, and it does not interfere with important segments of the economy. Instead, regulation comes from the people and the relationship between supply and demand.
The market economic system is mostly theoretical. That is to say, a pure market system doesn’t really exist. Why? Well, all economic systems are subject to some kind of interference from a central authority. For instance, most governments enact laws that regulate fair trade and monopolies.
From a theoretical point of view, a market economy facilitates substantial growth. Arguably, growth is highest under a market economic system.
A market economy’s greatest downside is that it allows private entities to amass a lot of economic power, particularly those who own resources of great value. The distribution of resources is not equitable because those who succeed economically control most of them.
- Mixed system
Mixed systems combine the characteristics of the market and command economic systems. For this reason, mixed systems are also known as dual systems. Sometimes the term is used to describe a market system under strict regulatory control.
Many countries in the West follow a mixed system. Most industries are private, while the rest, comprised primarily of public services, are under the control of the government.
Mixed systems are the norm globally. Supposedly, a mixed system combines the best features of market and command systems. However, practically speaking, mixed economies face the challenge of finding the right balance between free markets and government control. Governments tend to exert much more control than is necessary.
Economic policies
The economic policy of governments covers the systems for setting levels of taxation, government budgets, the money supply and interest rates as well as the labour market, national ownership, and many other areas of government interventions into the economy.
Most factors of economic policy can be divided into either fiscal policy, which deals with government actions regarding taxation and spending, or monetary policy, which deals with central banking actions regarding the money supply and interest rates.
Such policies are often influenced by international institutions like the International Monetary Fund or World Bank as well as political beliefs and the consequent policies of parties.
Types of economic policy
Almost every aspect of government has an important economic component. A few examples of the kinds of economic policies that exist include:
- Macroeconomic stabilization policy, which attempts to keep the money supply growing at a rate that does not result in excessive inflation, and attempts to smooth out the business cycle.
- Trade policy, which refers to tariffs, trade agreements and the international institutions that govern them.
- Policies designed to create economic growth
Policies related to development economics
- Policies dealing with the redistribution of income, property and/or wealth
- As well as: regulatory policy, anti-trust policy, industrial policy and technology-based economic development policy.
Tools and goals
Policy is generally directed to achieve particular objectives, like targets for inflation, unemployment, or economic growth. Sometimes other objectives, like military spending or nationalization are important.
These are referred to as the policy goals: the outcomes which the economic policy aims to achieve.
To achieve these goals, governments use policy tools which are under the control of the government. These generally include the interest rate and money supply, tax and government spending, tariffs, exchange rates, labor market regulations, and many other aspects of government.
Macroeconomic stabilization policy
Stabilization policy attempts to stimulate an economy out of recession or constrain the money supply to prevent excessive inflation.
- Fiscal policy, often tied to Keynesian economics, uses government spending and taxes to guide the economy.
- Fiscal stance: The size of the deficit or surplus
- Tax policy: The taxes used to collect government income.
- Government spending on just about any area of government
- Monetary policy controls the value of currency by lowering the supply of money to control inflation and raising it to stimulate economic growth. It is concerned with the amount of money in circulation and, consequently, interest rates and inflation.
- Interest rates, if set by the Government
- Incomes policies and price controls that aim at imposing non-monetary controls on inflation
- Reserve requirements which affect the money multiplier
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