M A ALPHA

Business Studies Department

PRINCIPLES OF BUSINESS
4th Form
Lesson Notes Types of Economic System

Economic system: An economic system refers to the way in which a country or nation plans to
utilize its scarce resources in order to achieve economic growth that will benefit its citizens.
Or
The term economic system refers the way society organizes its scarce resources to produce
goods and services to satisfy the needs and wants of the population.

The process of producing the things we will want to take place in a political framework; the
decision of what to be produce is limited by the resources a country has and is influenced by the
political situation within which the decision is made. No two countries are organized in the same
way, but they all have to solve the following basic problems.
 What should be produced? For example, what quantities of food, machinery or services
should be produced?
 How should be production be organized? What are the best ways to combine the factors of
production (land, labour, capital, enterprise)? Should automated or manual methods be
used? What technological equipment (for example, computers) is required? Where should
production take place?
 For whom should production take place? Should everyone be entitled to an equal share of the
production, or should some (for example, the wealthy) receive more than others:

Economist refer to these issues as, ‘the economic problem’ and they distinguish between four
different types of economic system which answer these questions
Types of Economic Systems
Economist have classified economic systems into the following types:
1. The traditional or subsistence economy
2. The planned, command, controlled or socialist economy
3. The free market or the market driven capitalist economy
4. The mixed economy

TRADITIONAL/SUBSITENCE ECONOMY

Traditional or subsistence economy: is an economy based on traditions and customs where

nearly the whole population is engaged in agriculture, producing just enough food for their own
needs. This is where humans focused on survival and not so much on improving their economic
wellbeing. There is little specialization of labour and little trade. In such an economy people live
in family groups and grow most of their own food. It is called a ‘subsistence economy’ because
people can do little more than provide only the basic necessities to survive.

Features
1. Existence is primarily based on traditions and customs
2. Barter was the main form of trade
3. Resources are owned or controlled by a sovereign or feudal Lord E.g. Remote tribal areas
in South America, Africa and Asia

Advantages Disadvantages
1. Every member of society knows exactly 1. Society is often slow to change
what they are to do.
2. There is a strong social network 2. It does not take advantage of technological
changes
3. Resources are owned or controlled by a 3. There is inefficient provision of goods and
soverign or feudal Lord e.g. Remote tribal service.
areas in South America , Africa and Asia

PLANNED/COMMAND/CONTROLLED/SOCIALIST ECONOMY

The planned, command or controlled economy: in this economy all the economic decisions are
made by the government. The state decides what will be produced, how it is to be produced and
how it should be allocated to consumers. In other words, it is the state that decides what the
community needs and therefore, demand is not influence by the consumer. All resources are
allocated to industries and product as decided by the government, e.g. health, education, social
services etc. Cuba, North Korea and China are all examples of the planned economy.
Features
1. All resources are government owned
2. One person (dictator) or group of officials decide WHAT products are needed
3. Government runs all businesses, control all employment
4. Government decides WHO received the products that are produced.
5. Price are set by the state
6. The government plans, coordinates and controls all economic activities
 Advantages
1. The state ensures that the needs of the population or whole community are met, and not
just the needs of those with the most wealth.
2. Little inequality of wealth or income
3. The state will provide goods and services that private enterprise would be unwilling to
provide.
4. No wasteful competition as the state controls production.
5. It is not possible for private monopoly to develop.
6. Low levels of unemployment and inequality

Disadvantages
1. Private firms do not exist to compete with each other and drive down prices
2. Little incentives for innovation and entrepreneurship
3. A free market and competition are discouraged
4. Creativity and efficiency are not encouraged
5. Too many non-productive government officials are required to administer the system.
6. State central planning isn’t often inaccurate, inefficient not gear towards people’s need.
There is little consumer choice.
7. Centralized production may not respond quickly to enough to changing conditions and
needs.
8. The government may have responsible for administering and implementing the plans.
This task may be too enormous for the technocrats working with the government and
hence there may be inefficiency in the delivery of goods and services.

FREE MARKET/MARKET/CAPITALIST ECONOMY

In the Free Market also known as Market Economy or Capitalist, decisions about what goods
and services to produce, the quantities produced and the prices they are exchanged for are
determined by the individual actions of many different producers and consumers. Private sector
businesses and individuals own and control the means of production (factors of production) and
will purchase goods and services based on their willingness and ability to pay for them. There is
very little role for government planning or activity in a free market economy.

Market forces are allowed to determine the how resources are allocated. Sometimes this type of
economy is also referred to as an unplanned economy, free enterprise or laissez-faire. There is
no example of a ‘pure’ 100 per cent free economy but the USA, Hong Kong and Singapore are
close examples.

Advantages of Free Market Economy

1. Free competition stimulates innovation and keeps prices down.

2. Individuals are completely free to use their income in labour to their best advantage.
 3. Consumers decide what will be produced by influencing market forces.
4. The profit motive encourages firms to be efficient.
5. Consumers choose how to spend money; firms are encouraged to produce goods that are
in high demand.
6. Competition among firm’s forces prices down.
7. There is greater efficiency in the use of the factors of production since market forces
determine the allocation of resources.

Disadvantages of Free Market Economy

1. This system encourages a highly unequal distribution of income and wealth. In a free-
market economy, businesses are owned by the wealthy that employ people of lower
economic status. As a result, the rich become richer and the poor often remain poor.
2. Businesses reduce competition to increase prices.
3. Some people's basic needs might not be met.
4. Advertising can be used to create an artificially high demand for products.
5. Companies may be tempted to restrict supplies to keep prices artificially high.
6. Wealthy people are more able to purchase goods and services and influence the market
than the poor.
7. The more powerful business may buy out the smaller ones, thus reducing competition.
8. Social and merit goods, for example health, defense, education and security, may ot be
adequately provided for

MIXED ECONOMY

Mixed economies are economic arrangements in which both government and private individuals
make economic decisions as to what to be produced, how to produce and for whom goods and
services should be produced. In this economy resources are owned and controlled by the private
and public sector. The mixed economy is by far the popular form of an economic organization
existing in the world today. Most countries, including the English-speaking Caribbean states,
have mixed economies.

In reality, there are no completely free-market economies or planned economies. All economies
are mixed to a greater or lesser extent. In a mixed economy, ownership of scarce resources and
decisions about how to use them are split between the private sector and a public sector
consisting of government authorities and organizations.

Or

A mixed economy (also called dual economy) is a combination of elements from a free
economy
and a
controlled
economy;
it is a mixed
system.
The means
of production and supply are shared between the private and public sector. There is a public
sector very much influenced and controlled by the state, and a private sector in which
individuals’ risk capital in producing goods and services for profit, and market forces have
maximum influence. The reality is that all Caribbean countries today have a mixed economy, but
some lean more towards the free market and some lead towards central planning as illustrated by
the chart below

Features/Characteristics of the Mixed Economy

1. Economic decisions are taken by the price mechanism system and also by the state.
2. The private business sector operates along the lines of the free market, where price
mechanism determines allocation of resources.
3. The aim of the private sector is to maximize profit while the aim of the public sector is to
maximum social welfare.
4. The public sector provides goods and services that the private sector is unable to produce.
5. Involvement of both state and private individuals.
6. Efficient use of resources.
7. More equitable distribution of income than free-market economies.

Advantages/Benefits of Mixed Economies

1. The state can intervene in areas of the economy through the passing of laws to protect
consumers.
2. Government and private sector can cooperate in the delivery of certain services through
franchising.
3. Both sectors of the economy, the government and private individuals, engaged in
activities that can best produce, and therefore there is a more efficient use of resources.
4. A wide variety of goods are available since the government complements those goods
and services that are provided by private sectors.
5. Governments are free to make laws to protect natural resources and people.

Disadvantages/Limitations of Mixed Economies

1. Too much government regulation may dampen the free enterprise spirit.
2. Some stated-owned industries are allowed to operate inefficiently thus wasting resources.
3. Government intervene in the market by setting maximum and minimum prices.
4. There is always a need to keep a balance between government and private sector
involvement.
5. Conflict may arise between the government and private investments and thus result in
long delays in the production of goods and services