Principles of Economics

PRC-3

Chapter # 1 Topic# 5
Economic System Socialism &
Capitalism (MSc.
MSc.Economics-Banking
Economic ( Banking&& Finance, MBA
Finance), Marketing,
MBA, MS-IT,
MS Business Management,
MS - Project Analysis- MS-IT)
Investment & Finance
 Introduction to
Economics & Finance

Definition of Factors of
Production Possible
Economics Economic Problem Economic Agent Production & Types of Economics Economic System
Curve
Returns
 Economic System
Economic system refers to the institutional arrangement to allocate the scarce
resources to produce maximum goods and services for the betterment
satisfaction of society.
 Socialism-Planned Economy
A type of economy in which some central authority makes a wide range of
decisions pertaining to production and wages. The former Soviet Union and
other communist nations are examples of planned economies

An economic system in which resources are allocated by the decision of

government rather than market.
3) A17 (i) Which of the following is NOT a basic question of economics?
(a) What will be produced?
(b) Where it will be produced?
(c) For whom will it be produced?
(d) Who will produce it?

(i) (b) Where it will be produced?

 Features of Planned Economy
Resource are considered to be collectively own by society.
Central planning board decides questions of what, how and whom.
Productive resources are state owned and the state decides how they should
be used, even allocation of houses, cars is done by the state through planning.
Resources are allocated by through an administrative system which decides
how much goods and services to produce.
 Advantages of Planned Economy
1- No Monopoly: Since government has control over all factors of production the
chances of monopoly happening are next to nil under planned economy.
2- No class conflict: It may help in reducing the gap between poor and rich
because all government policies are designed to bring social equality which may
sometimes lead to dictatorship sort of environment.
3- No unemployment: Full employment of the workforce is possible.
4- Economic stability and no waste of resource: Production is carried out for the
needs of society and not for the benefit of the few. Less duplication and waste of
resources which permits long term industrial and social planning fostering
economic stability.
5- Welfare for all: Basic needs are protect, every person insured for his/her
education, food, shelter and clothing.
 Disadvantages of Planned Economy:
1- Low Growth & Innovation: It leads to destruction of entrepreneurs and
innovators which in turn leads to lower productivity and also lower growth for a
country. Lack of profit motive and competition makes the economy inefficient.
2- Bureaucracy: This system suffers from government bureaucracy, delay in
decision making on the part of government officials bottlenecks in production
and inefficient use of resources. Bureaucratic and slow to respond to changing
needs or technology.
3- No Choices: Loss of consumer sovereignty to planners reduces welfare
4- No Freedom of expression and political moves: Lack of economic and political
freedom.
Q2 Q.1_A17: (b) What do you understand by the term ‘Planned economy’?
How resource allocation choices are made in a planned economy? Also state
any three benefits of planned economy. (05)
 Market Economy
An economic system in which resources are distributed through demand
and supply forces.
 Features of Market Economy
1- Right of ownership:
In free market economy the private ownership of property is allowed. The people
can own the property; they can increase their productive resources and even
transfer them into their heirs after death.
 Features of Market Economy

2- Price mechanism:
Price mechanism refers to the way in which prices act as signals to coordinate
the economic activities of economic agents.
3- Consumer sovereignty /Liberty of consumer choice:
People have freedom to spend their money on the goods and services they like.
It is the consumer who determines what the producer should produce.
 Features- Market Economy

Features/characteristics:
4- Profit maximization:
Private producers allocate their scarce recourses because of the profit they
expect to earn in the business.
5- Competition and waste of resources:
This promotes competition among the producers which enhances the quality of
the product but sometime waste resources by over-production and extensive
advertising for product promotion.
 Benefits of Market Economy
1- High efficiency: Competition between different firms leads to increased
efficiency, as firms do whatever is necessary—including laying off workers—to
lower their costs. Most people work harder (the threat of losing one's job is a
great motivator)
2- Innovation and creativity: There is more innovation as firms look for new
products to sell and cheaper ways to do their work.
3- Motives and skills: Many people quickly acquire the technical and social skills
and knowledge needed to function in this new economy
4- Variety of Goods: A great variety of consumer goods become available for
those who have the money to buy them; and
5- Automatic adjustment: Price mechanism refers to the way in which prices act
as signals to coordinate the economic activities of economic agents. In pure free
market economy, the economic agents are producers, consumers and factors of
production. They make their decisions according to the price
 Drawbacks of Market Economy
1- Distorted investment priorities: as wealth gets directed into what will earn
the largest profit and not into what most people really need (so public health,
public education, and even dikes for periodically swollen rivers receive little
attention)
2- Worsening exploitation of workers: since the harder, faster, and longer people
work—just as the less they get paid—the more profit is earned by their employer
3- Overproduction of goods: since workers as a class are never paid enough to
buy back, in their role as consumers, the ever growing amount of goods that they
produce.
 Disadvantages of Market Economy

4- Class conflicts: Growing social and economic inequality (the rich get richer and
everyone else gets poorer, many absolutely and the rest in relation to the rapidly
growing wealth of the rich).
5- Environmental degradation: Worsening ecological degradation (since any
effort to improve the quality of the air and of the water costs the owners of
industry money and reduces profits, our natural home becomes increasingly
unlivable
Q11 Q.1_A11: (a) What do you understand by the concept of “Consumer
Sovereignty”? (02 marks)
(b) Briefly describe the demerits of Free Market Economy.
(07 marks)
Q15 Q2.4_QB A MARKET ECONOMY
(a) Explain how the price system works to allocate resources in a market
economy. (10)
(b) Describe the main reasons why markets do not always allocate resources in
an efficient manner. (10) (20)