Reading: Lesson 5 - Economic Systems

4.5.A - Economic Systems

1. ECONOMIC SYSTEMS

1. No country or state has enough resources to satisfy all the wants of all people for material goods and services. Because productive resources are scarce, difficult decisions must be made about how to use these limited resources. For example, businesses and governments decide whether to produce more capital goods and fewer consumer goods or more consumer goods and fewer capital goods. All countries have an economic system. An economic system is an organized way to decide how to use productive resources; that is, to decide what, how, and for whom goods and services will be produced. While there are many countries in the world, all economies operate under some form of three basic economic systems.
   
2. The primary types of economic systems are market, command, and mixed economies. While economists will refer to some economies as predominantly market- oriented or command-controlled, all economies are mixed to some extent.
   
3. A market economy is an economic system in which individual buying decisions in the marketplace together determine what, how, and for whom goods and services will be produced. For example, if more consumers choose to buy whole-grain bread, these buying decisions will influence bread producers to use their productive resources to produce more whole-grain bread instead of white bread. Thus, consumers each make individual decisions about what goods are desirable yet collectively determine how the society’s productive resources will be used. In a market economy, individual citizens, rather than the government, own most of the factors of production, such as land and manufacturing facilities. The free-enterprise system found in the United States is an exceptional example of a market economy under the political-economy system called capitalism, which will be discussed later.
   
4. A command economy is an economic system in which a central planning authority, under the control of the country’s government, owns most of the factors of production and determines who produces goods and services, what is produced, and when and how. Countries that adopt a command economy are often dictatorships. The government, rather than consumers, decides how the factors of production will be used. Forms of command economies exist in China, Cuba, Iran, and North Korea.
   
5. A mixed economy is an economic system that uses aspects of a market and a command economy to make decisions about who produces goods and services, what is produced, and when and how. In a mixed economy, the national government makes production decisions for certain goods and services. For example, the postal service, schools, health care facilities, and public utilities such as water and sewer service are often owned and operated by governments.
   
6. No country has a pure market economy or command economy. All have mixed economies, although some have more elements of a market economy and others have more elements of a command economy. In the United States and Canada, for example, the government plays a smaller role in the economy than it does in the more command-controlled economies of Cuba and North Korea. Even countries of the former Soviet Union, once a predominantly command economy, now allow most privately owned businesses to operate freely and make their own economic decisions, such as what to offer for sale and at what prices.
   
7. Today most countries are moving more toward market economies. For example, countries in Eastern Europe as well as nations such as England, France, and Mexico have restricted the number of goods and services owned and controlled by national governments. China also has been making major attempts to move more toward a market economy. Privatization is the transfer of authority to provide a good or service from a government to individuals or privately owned businesses. Some governments of former Soviet countries have sold telephone and transportation services to private firms. Some states and cities have privatized by paying businesses to operate jails, collect trash, run cafeterias in government buildings, and perform data entry and customer support functions. The government’s incentives are to reduce costs for taxpayers and to increase efficiency.
   

2. TYPES OF POLITICAL-ECONOMY SYSTEMS

1. Each country has a political system and an economic system. The political system nearly always determines the economic system. Because the two systems cannot be separated, we refer to them as a political-economy system. The importance of the individual citizen has always been emphasized in the United States. Therefore, the United States developed a political-economy system that permits a great deal of individual freedom. History tells us that there is a relationship between political and economic freedom; that is, political freedom usually is found in countries where individuals and businesses have economic freedom. Political freedom is quite limited in countries that do not give people and organizations much economic freedom.
   
2. All political-economy systems are forms of three basic types: capitalism, socialism, and communism. As you read about these three political-economy systems, compare their features as shown in the Figure below. 
   

   
   

3. The political-economy system in the United States is called capitalism, or the free-enterprise system, which operates in a democracy. Capitalism is an economic- political system in which private citizens are free to go into business for themselves, to produce whatever they choose to produce, and to distribute what they produce. Also included is the right to own property as the means of production; a key component of capitalism is the ability of individuals to own the property needed to produce capital goods.
   

4. This strict definition of capitalism would have accurately described our economic system during much of the nineteenth century and the early part of the twentieth century. In recent decades, however, government has assumed an important economic role in the United States. As the economy developed without controls by government, certain abuses took place. For example, some people began to interfere with the economic freedom of others. Some large businesses began to exploit small businesses that were not protected by regulation on fair competition. Manufacturing firms did not take into account the costs of air, soil, and water pollution. In essence, these costs were passed on to the public.
   

5. For example, assume a firm produced a new type of pesticide and sold it to farmers and gardeners. The pesticide was found to kill fish and harm swimmers years later after washing into streams and lakes. When neither the producer nor the buyers of the pesticide are required to pay for damages, the public ultimately pays in the form of poor health and medical costs as well as in the inability to safely swim in lakes and other bodies of water. To protect the public and to correct such abuses, Congress passed laws, many of which require producers to avoid harm to the public or reduce the costs to the public of a producer’s operations.
   

6. Socialism is a political-economy system in which the government controls the use of the country’s factors of production. How scarce resources are used to satisfy the many wants of people is decided, in part, by the government. Practitioners of socialism do not agree as to how much of the productive resources government should own. The most extreme socialists want government to own most natural resources and capital goods. Middle-of-the-road socialists believe that planning production for the whole economy can be achieved if government owns certain key industries, but they also believe that other productive resources should be owned by individuals and businesses. As a result, socialism is often associated with mixed economies.
   

7. Socialism limits the right of the individual to own property for productive purposes. The right to own property, however, exists in socialistic economies in different degrees, depending upon the amount of government ownership and control. Socialism in its different forms exists in many countries, particularly in the Western European countries of Sweden and France. 
   

8. Communism is extreme socialism, in which all or almost all of a nation’s factors of production are owned by the government. Decisions regarding what to produce, how much to produce, and how to divide the results of production among the citizens are made by government agencies on the basis of a central plan. Government measures how well producers perform on the basis of volume of goods and services produced, without much regard for the quality of or demand for the goods or services. A command economy is most often practiced by communist countries.
   

9. Consumer goods are often in short supply in communist countries such as Cuba and North Korea, because the government channels a large proportion of the factors of production toward capital formation. Chinese leaders recently have recognized the shortcomings of the system when it comes to meeting the needs of consumers. As a result, they are making adjustments that introduce market economy principles. Two such adjustments include judging the performance of producers by the demand for their products and permitting consumer demand to influence production.
   

10. Workers in a communist system cannot move easily from one job to another, and managers of businesses do not decide what is to be produced. A communist country’s central planning agency makes such decisions. Capitalism relies, instead, on consumers and managers to make these decisions. People in a pure communist society do not own property. All economic decisions are made by government leaders. These leaders decide how scarce resources will be used. The citizens of a communist country have few of the economic freedoms that Americans believe are important.