TOPIC 2

TYPES OF ECONOMIC
SYSTEMS
(CONVENTIONAL)
AEDF 0633
  Introduction to economic systems
 Market economy
■ Definition
■ Characteristics
■ Merits
■ Demerits
■ Summary

 Command economy
■ Definition
CONTENTS ■
■
Characteristics
Merits
■ Demerits
■ Summary

 Mixed economy
■ Definition
■ Characteristics
■ Merits
■ Demerits
■ Summary
 INTRODUCTION
• Every country >>> limited resources with alternative uses
to produce goods and services to satisfy unlimited human
wants.
• An economic system >>> the way economic agents
(households, firms, factor owners, and the government) in a
country resolve the three basic questions of “what to
produce”, “how to produce”, and “for whom to
produce”.
• Economic systems are conventionally classified into three;
• the market economy (capitalism/free market/laissez-faire
economy),
• command economy (socialism/centrally planned economy),
and
• the mixed economy; according to their political-social
framework.
 INTRODUCTION
•Accordingly, an economic system performs five major
functions.

i. Allocation of resources.
ii. Organisation of production.
iii. Distribution of finished goods.
iv. Maintenance of economic stability.
v. Promotion of economic growth.
The way in which an economy performs its five functions
depends on the political-social framework of the country.
MARKET ECONOMY
 DEFINITION

An economy in which households, firms, and

owners of resources decide what goods and
services to produce, how they are to be produced, and
who will benefit from the production of these goods and
services.
 CHARACTERISTICS

• In this economy, the system

• In a market economy, the is based on private
decisions about resource enterprise and private
allocation are left to the ownership of resources.
market forces of supply • In a totally free market
and demand i.e., price economy, the government
mechanism. does not interfere with
the price system.
 CHARACTERISTICS

• The households have the • Economic productivity and

freedom to decide what efficiency depend on how
they want to buy. It is their optimal the price
choice that influences the mechanism allocates
producers’ decisions. resources.
• This is the concept of • Although consumers enjoy
consumer sovereignty; sovereignty, economic
consumers’ decisions agents must face instability
determine which goods and in income with the ebb and
services will be produced. flow of the business cycle.
 MERITS

DECISIONS ARE MADE QUICKLY

INCENTIVES TO WORK

ECONOMIC EFFICIENCY

COMPETITION
 MERITS

1. Decisions are made

quickly.
2. Incentive to work.
• All economic decisions are
made through the price • Because all profits are
mechanism. For example, privately owned, producers
market prices will rise if work hard to accumulate as
there is increased demand, much wealth as possible.
and market prices will fall if
there is decreased demand.
 MERITS

3. Economic efficiency.
4. Competition.
• The concept of efficiency
• In this economy, firms are
refers to the maximum
free to compete between
output that can be produced
themselves. This
with limited resources or
competition will encourage
input. Because the aim of a
technological innovation and
firm is to maximise profit,
advancement, which will
the firm must ensure its
contribute to a higher level
production is always at a
of satisfaction.
high level of efficiency.
 DEMERITS

SOCIAL WELFARE NEGLECTED

SOCIAL GOODS UNSUFFICIENTLY PRODUCED

NEGATIVE EXTERNALITIES

WASTAGE OF RESOURCES

MONOPOLY

PRICE INSTABILITY
 DEMERITS

WIDE INCOME DISTRIBUTION GAPS

THE ECONOMY DOES NOT ACHIEVE FULL EFFICIENCY

INEFFICIENT ALLOCATION OF RESOURCES

CONFLICT OF OPINIONS BETWEEN PRIVATE AND PUBLIC SECTORS

UNEVEN DISTRIBUTION OF INCOME

EMERGENCE OF ILLEGAL ACTIVITIES AND NEGATIVE INFLUENCES

 DEMERITS
2. Social goods insufficiently
produced.
• Social goods are non-exclusive;
1. Social welfare neglected. the free market does not
produce all the goods that
• In a free market, social people want and are willing to
welfare is often neglected, as pay for. Generally, the
firms are focused on production of social goods
maximizing profits. Social increases the welfare level of
responsibility is often society and does not generate
forgotten. profit. Therefore, the private
sector will not produce social
goods.
 DEMERITS

3. Negative externalities.
4. Wastage of resources.
• Negative externalities are
• Wastage of resources often
negative external effects arising
occurs in a free market
from uncontrolled industrial
economy. For example,
expansion i.e., pollution of the
competition between firms will
environment. Pollution from
lead to the payment of
disposal wastes and toxic
advertising costs, which can be
materials is a social cost to the
non-profitable.
local community.
 DEMERITS

6. Price instability.

5. Monopoly.
• In a market economy, the
government does not control
• Free competition between firms prices of goods. Prices of goods
in a market economy may result are determined by the price
in a monopoly. The emergence mechanism. The uncontrollable
of a monopoly may negatively nature of the mechanism may
impact consumers. negatively impact the lower
income consumers, especially if
the goods are a necessity.
 DEMERITS

7. Wide income distribution 8. The economy does not

gaps. achieve full efficiency.
• In a free market, there is often a • Market economists believe that
large income distribution gap unemployment will not exist in
between the rich and the poor. the economy. However, the
This may result in a supply of labour always exceeds
disharmonious community, the demand for labour.
which may affect the economic Therefore, unemployment will
growth of the country. always occur in the economy.
 DEMERITS

9. Inefficient allocation of 10. Conflict of opinions

resources. between the private sector and
the government.
• In a market economy, goods are
not produced to fulfill wants, but • The conflict of opinions between
reap profit. Not enough social the two exists when it comes to
goods that are important to the issue of providing for public
increase the welfare of society welfare i.e., education, health,
are produced. The efficient infrastructure, defense, etc., with
allocation of resources is when the focus of the private sector is
the resources are used to on producing goods and services
produce goods that are for daily consumption (profit-
genuinely needed by society. making).
 DEMERITS

12. Emergence of illegal

activities and negative external
11. Uneven distribution of influences.
income.
• Private sector in making more
• The rich income group will than normal profit often involve
continue to accumulate wealth themselves in illegal activities
whereas the condition of lower and tend to avoid paying the
income group will remain the penalties or facing legal actions
same. by the government i.e., illegal
selling, selling prohibited items,
illegal disposal of toxic wastes,
etc.
 SUMMARY
• A market economy is an Functions Solutions
economic system that does What goods and services should Determined by the power of price
not involve government be produced? mechanism i.e., the power of demand
intervention in its and supply.
economic activities. All
How much goods and services Determined by the price mechanism
economic decisions are should be produced? i.e., market demand and supply.
determined by the price
How goods and services should Firms/producers will choose the most
mechanism. be produced? cost-effective production methods.

• Economic resources are The goals are to maximise the output

while minimizing the costs.
solely owned by private
parties and are freely For whom the goods and Determined by individual purchasing
services should be produced and power and income. Firms/producers
utilized by individuals.
distributed? will supply to those who are willing to
Individuals and producers pay i.e., demand.
have freedom of choice.
COMMAND ECONOMY
 DEFINITION

An economic system that involves direct

government intervention in the planning and
control of economic activities.
 CHARACTERISTICS

• It decides the type, quantity, and

quality of each good to be
• A command economy is a produced.
centrally planned economy.
In the economy, the • It also determines the
quantity of resources to be
government makes
employed in producing the
economic decisions for the
goods and services, the method
people. It uses directives to
of production and the quota
control the economy.
for each individual
production, and even the type
of employment of each
worker.
 CHARACTERISTICS

• In a centrally planned economy, • Economic productivity and

the government believes that efficiency depend on how
it is in the best position to accurate the government has
decide what to produce, forecast wants and allocated
how much to produce, how resources to meet them.
to produce and for whom to
produce.
• While people in the economy
have limited freedom in their
• All economic resources are economics decisions, they
publicly owned and there is enjoy greater security and
no private profit. social equality.
 MERITS

ENCOURAGE MASS PRODUCTION

FAIR AND EVEN DISTRIBUTION OF WEALTH AND INCOME

PRODUCTION WITHOUT COMPETITION

CREATE THE EFFICIENT USE OF RESOURCES

CREATES ECONOMIC STABILITY

PRIOTISES THE PRODUCTION OF PUBLIC AND SOCIAL GOODS

ILLEGAL ACTIVITIES AND NEGATIVE EXTERNAL INFLUENCES ARE REDUCED

 MERITS

2. Fair and even distribution

of wealth and income.
1. Encourage mass
production.
• There will be no gap between
the rich and the poor.
• Production is up to maximum Individuals have no freedom of
with minimum usage of factors owning properties, and the
of production. government determines the
distributions of the factor and
income.
 MERITS

4. Creates the efficient use of

resources.
3. Production without
competition. • The resources are used
efficiently for the overall benefit
• There will be a mass production
of society. Resources are not
determined by the government.
earmarked for certain segments
of society.
 MERITS

5. Prioritises the production

4. Creates economic stability.
of public and social goods.
• The welfare of society is the
• The government provided more
utmost technique of production.
public goods because the
Therefore, unemployment is
economic decisions are
minimal or dies not exist.
determined by the government.
 MERITS

6. Illegal activities and

negative external influences
are reduced or eliminated.
• This effect can be controlled by
the government i.e., traffic
congestion, pollution, etc.
 DEMERITS

DELAY IN DECISION MAKING

LACK OF MOTIVATION AND INCENTIVE TO WORK

DEVELOPMENT OF TECHNOLOGY AND INNOVATION NOT ENCOURAGED

LIMITED INDIVIDUAL CHOICES

 DEMERITS

BUREAUCRATIC PLANNING AND ADMINISTRATION

POSSIBILITY OF INEFFICIENCY IN DISTRIBUTION OF RESOURCES

LACK OF INDIVIDUAL EFFORTS

LACK OF COMPETITION
 DEMERITS

2. Lack of motivation and

1. Delay in decision-making.
incentive to work.
• The delay in making decisions
• Productions are slow because
by government may exist
of low motivation of the
because the motivation is to
producers. Goods are produced
give priority to the welfare of
as per instruction of the
the people, rather than profit.
government.
 DEMERITS

3. Development of technology 4. Limited individual choices.

and innovation not
encouraged.
• There is no freedom in private
ownership because all
• Technological development and properties and factor of
innovation are slow due to lack production are owned by the
of competition in the economy. government.
 DEMERITS

5. Bureaucratic planning and

administration. 6. Creates the possibility of
inefficiency in the
• The government plans and
distribution of resources.
makes the decisions for all the
economic activities according to • This economy does not create
the wish of the people. The efficiency in production.
government decided the Priority is given to human
distribution by determining the resources rather than efficiency.
prices.
 DEMERITS

7. Lack of individual effort.

8. Lack of competition.
• The government determines
what and how much tom • Since production is controlled
produce according to the by the government, there is a
demand and welfare of people. lack of competition among the
There is no freedom to work producers to come up with
because all the economic innovative ideas for
activities are controlled by the improvement.
government.
 SUMMARY
• A command economy is an Functions Solutions

economic system that What goods and services should Determined by the government or
involves direct government be produced? ruling authority.
intervention in the planning How much goods and services Determined by the government or
and control of economic should be produced? ruling authority based on priorities
activities. i.e., necessities and social welfare.

• Economic decisions are How goods and services should

be produced?
Based on the government’s goal of
maximizing the outputs to fulfill the
made by the government. wants of the society. Production
Consumers and producers techniques are chosen based on social
do not have freedom of welfare.

choice. Social welfare is For whom the goods and Goods and services are distributed
prioritized, resulting in the services should be produced and fairly. The government controls the
production of more social distributed? prices and distribution to ensure
goods. equality for all.
MIXED ECONOMY
 DEFINITION

An economic system where the private sector and

the government will make economic decisions
together.
 CHARACTERISTICS

• A mixed economy is a hybrid • Many countries operate a

between a market economy and mixed economic system
a command economy. In the with a large private sector based
economy, the market or price on private enterprise along with
mechanism exists, with the substantial government
government playing an intervention.
important role in the
economy as well.
 CHARACTERISTICS

• In a mixed economy, the • It may also intervene to

government intervenes to correct social inequalities,
correct any failure in a pure redistribute income and wealth,
market system. It may intervene check unfair use of power by
directly to supply goods and monopolies, control price levels,
services that private firms are and reduce socially undesirable
reluctant or unable to provide in consequences such as pollution.
sufficient quantities or at an
acceptable price.
 CHARACTERISTICS

• The government intervenes in

the economy by
formulating and
implementing
macroeconomic policies.
The aims of the government
are to ensure efficiency,
equity, and stability in the
economy.
 MERITS

COOPERATION BETWEEN PUBLIC AND PRIVATE SECTORS

MORE OPTION AND CHOICES

EFFICIENT RESOURCES ALLOCATION

SOCIAL WELFARE PRIORITISED

PREVENTION AND CONTROL OF MONOPOLY

 MERITS

GUARANTEED ECONOMIC STABILITY

INCENTIVES TO WORK

PROHIBITION OF ILLEGAL ACTIVITIES AND NEGATIVE INFLUENCES

PRODUCTION OF PUBLIC GOODS

 MERITS

1. Co-operation between public

and private sectors. 2. More options and choices.
• In a mixed economy, the public • In a mixed economy, the
and private sectors are involved in government produces public
the production of goods to satisfy
goods, while the private sector
the needs of consumers and
increase social welfare. The private
produces private goods.
sector produces goods for profit Therefore, more types of goods
while the public sector produces are produced in a mixed
goods for social welfare. This economy.
results in efficient resource
allocation and increased quality of
life.
 MERITS

4. Social welfare prioritized.

3. Efficient resource
allocation. • The government will produce
public goods and control the
• The government and private
prices of public goods to ensure
sector compete to obtain
a high quality of life. The
resources and produce goods.
government also ensures the
However, government can
welfare of lower income groups
intervene if competition for
through assistance such as
resources becomes unhealthy.
subsidies.
 MERITS

5. Prevention and control of 6. Guaranteed economic

monopoly. stability.
• The government can control the • In a mixed economy, problems
price mechanism and maintain of economic stability caused by
the freedom of competition free market system and price
between firms to curb mechanism can be overcome,
monopoly. In a mixed economy, through government
the government can implement interventions such as fiscal and
anti-monopoly laws, ceiling monetary policies. This will
prices and impose taxes on ensure efficient use of resources
monopolies. and eventually ensuring full
efficiency.
 MERITS

8. Prohibition of illegal
7. Incentive to work.
activities and negative
• Individuals and firms have the external influences.
freedom to run economic
activities and reap profits.
• The problems of illegal activities
and negative influences can be
Increased efforts from
overcome through the
individuals and firms increase
enforcement of laws and
the country’s production and
regulations by the government.
quality, and lead to the
Thus, ensuring the quality of life
improvement of life quality.
and social harmony.
 MERITS

9. Production of public goods.

• In a mixed economy, the
government produces public
goods to increase social welfare
levels. The private sector does
not produce public goods which
are capital-intensive, have high
production costs and require
complex technology.
 DEMERITS

CONFLICT OF OPINIONS; PUBLIC VS PRIVATE

UNEVEN DISTRIBUTION OF INCOME

POSSIBILITY OF MARKET AND ECONOMIC INSTABILITY

EMERGENCE OF ILLEGAL ACTIVITIES AND NEGATIVE INFLUENCES

POSSIBILITY OF INEFFICIENCY IN THE USE OF RESOURCES

POSSIBILITY OF CONFLICT; PUBLIC VS PRIVATE

 DEMERITS

1. Conflict of opinions between

private sector and the
government. 2. Uneven distribution of
income.
• The conflict exists when it comes
to public welfare. The firms are • The rich income group will
concerned more on producing continue accumulating wealth
goods and services of daily whereas the condition of the
consumption (profit-making), poor will remain the same.
while the government concerns
on the general welfare and
public goods and services for all.
 DEMERITS

4. Emergence of illegal
activities and negative
3. Possibility of market and
external influences.
economic instability.
• Due to the quota system, the
• Private sector needs more than
normal profit will involve
tendency of misconduct for
themselves in illegal activities
profit-making lead to black
and avoid from paying penalties
market and price hike.
and legal actions by the
government.
 DEMERITS

5. Possibility of inefficiency in 6. Possibility of conflict

the use of resources. between private sector and
the government.
• Only a few firms are interested
in indulging in social activities • Government’s involvement in
since government intervention the price mechanism for public
in business activities gives interest and security will create
priority to the welfare of the dissatisfaction among the
community compared to private sectors. The revenue is
monetary gain i.e., lack of check dominated by the government
and balance. and a strike may happen.
 Functions Solutions

What goods and services should Determined by the power of price

be produced? mechanism i.e., the power of demand
and supply.

SUMMARY The government will produce goods

and services that are not produced or
offered by the private sector i.e.,
public goods, social welfare.

How much goods and services For the private sector, it is determined
should be produced? by the price mechanism i.e., market
demand and supply.

• A mixed economy is an The government will supply/produce

economic system where the public goods for the society.
private sector and the How goods and services should Firms/producers will choose the most
government will make be produced? cost-effective production methods.
economic decisions together. The goals are to maximise the output
while minimizing the costs.
• The government will intervene The government will decide on the
if there is any weakness in the production methods based on social
price mechanism. benefits and social costs.

For whom the goods and Determined by individual purchasing

services should be produced and power and income i.e., demand.
distributed?
The government control the income
gap through taxes, subsidies, welfare,
and zakah.
 EXERCISE 2
1. Which of the following is NOT a characteristic of free
market model?
A. consumer sovereignty
B. control of monopolies
C. private ownership of property
D. free working of the price mechanism
2. One function of the price mechanism is to:
A. eliminate surpluses of a good by allowing the market price to rise.
B. encourage government intervention to reduce inequality in the distribution of
income.
C. signal changes in consumer demand for a good to producers.
D. maintain price stability.
 ~REFERENCES~

Choo, T. H; Ahmad, N; Nisa, Z; Ramli, M. I; Ghani, R. A. (2017).

Fundamentals of Economics. Oxford

Hasan, Z. (2015). Economics with Islamic Orientation. Oxford