Economic systems are typically classified in four groups: traditional, command, market, and mixed-market. They each have strengths and weaknesses in different areas. They all serve the same purpose, which is organizing resources and helping societies deal with the problem of scarcity.
Traditional economies attempt to answer the three basic economic questions through tradition. A tradition is a custom or belief that is passed down from generation to generation. What sorts of traditions have been passed along to you? Can you imagine running an economy on tradition? In our society, it would be pretty difficult since our economy is so large, but traditional economies work well in small, close-knit societies. They are usually found in rural, non-developed areas and are governed by customs. Some sections of the Middle East, Africa, and South America have traditional economies. Technology is not developed, and every task is done the same way it was the generation before. Most activities are centered on the family, and there is very little change from generation to generation.
A good example of a traditional economy was found in Medieval Europe. Feudalism, a socioeconomic system based on tradition, dominated European society. In this society, if your parents were nobles, you were a noble. If your parents were serfs, you were a serf. There was no way for people to work their way up in society. Social ranks and economic levels were all determined by tradition.
Traditional economies are successful at the economic goals of stability and full employment. In traditional economies, everyone has a role or a duty in the economy. They also use all of the resources around them in order to produce. The goal of full employment comes fairly easily. Traditional economies are stable because they have been around for a long time. Typically, traditional economies are also efficient. They have been producing the same way for so long that they have perfected their process. They are efficient in their traditions, yet they lack the ability to change and grow.
The main weakness of a traditional economy is its resistance to change. The attitude that “tradition dominates” prevents economic growth and economic mobility. The goal of economic growth can never be achieved in a traditional economy. Since society is guided by tradition, there is no room to move up (or down) in society. Equity is usually not achieved because of these traditional attitudes. Children are encouraged to follow in their parents’ footsteps and have little incentive for advancement in society.
Command economies are also known as “planned economies.” They attempt to answer the three economic questions by relying on a central or command authority. In a command economy, the central authority (usually the government) dictates the economic behavior of the individuals.
All property is publicly owned, meaning that individuals cannot own property. The government also owns the means of production: raw materials, factories, farms, and other resources used to produce goods and services.
The command authority decides how resources are going to be used. The central authority gathers information and then develops a plan. The plan includes all of the goals for the economy, including production quotas. They make goals such as “our country will make one million cars this year.” The central authority then builds a factory and employs workers in order to make the quota.
The authority owns and runs all industry and determines the jobs and wages of workers. Factories are expected to meet the specific quotas determined by the government. There is no competition, so the government establishes the prices of goods and services. There is very little freedom because the government makes all of the economic decisions. Some modern-day examples of this type of system are Cuba, China, and North Korea. If you are unsure where these countries are located, look at this map.
One strength of command economies is their ability to change relatively quickly. For change to occur, the government simply needs to decide to put the change into action. It is because of this that they can achieve economic objectives in a very short period of time. This allows for the economy to adapt easily to differing needs. A second strength is that command economies usually have a high degree of equality among the working class. Income is distributed by the government, so it is fairly easy to maintain equal income distribution. The government assigns jobs to all, and everyone who is able is required to work. In most command economies, you are sent to prison if you do not work. The government employs all of the people, and all of the resources are at the disposal of the government.
One weakness of a command economy is that the central authority creates plans based on what it believes will be for the greater good of the state. Often goods are produced that people do not want, making the goal of economic efficiency impossible to achieve. Another weakness is that equity—dealing fairly and equally with all concerned—may also be difficult for command economies to achieve because a small group of leaders decides what is equal for all. Each individual’s opinion on what is equal will be different from another’s opinion. Also, although it would be ideal if the government treated everyone the same (treated everyone equally), it most often is not the case; thus equity, where everyone truly is dealt with completely equal, cannot be achieved in command economies.
The main weakness in a command economy is its lack of economic growth. Workers do not have an incentive to work hard. They have motivation to go to work, but there is no incentive to develop new products. All profit from industry goes to the government and is then distributed to the individuals. Entrepreneurs have no motivation in a command economy, which is why most command economies do not grow economically. For example, when the Soviet Union collapsed, it was estimated that their technology was about twenty years behind that of the United States. A main reason for this is the lack of worker motivation.
Market economies are often referred to as “capitalist economies.” They answer the three economic questions by giving economic freedom to individuals and businesses and letting them make the decisions based on supply and demand.
The definition of a market economy is an economic system in which the means of production are privately owned and individuals make the economic choices. Businesses are free to decide what they want to produce and how they want to produce it. Consumers are free to decide what they want to buy and how much they want to pay. Private property rights encourage individuals to take care of their property. Ownership of property helps to motivate individuals and businesses to conserve resources and work to improve the value of their property. The United States meets the definition of a market economy.
A market economy consists of numerous markets that all direct the way the economy will function. A key element of a market economy is voluntary exchange. Sellers and buyers exchange products only when they desire to do so. Voluntary exchange means that the trade between both parties is voluntary, not mandated by government decree. Prices are determined through the interaction of buyers and sellers. Sellers want to produce goods and services at low cost and sell them for as much as possible in order to gain a profit. Buyers want to buy the highest quality good at the lowest price. These two competing ideas work together to determine prices. We will go into this idea in more detail in unit 3.
Economic decisions are made by individuals competing to make profit. Competition among businesses is the driving force of market economies. Businesses are motivated to develop better production methods so that they can beat out the competition.
In a capitalistic society, resources are owned and controlled by individuals. There is no central authority with power over the economy. The economic power lies within the consumer. The consumers determine the goods and services that will be provided by making known exactly what they want. This is known as a laissez-faire, or hands-off, economy. The government implements a hands-off approach to the economy. That is, the government does not interfere with the economy. Check out the Federal Trade Commission website.
A significant strength of market economies is their ability to foster economic growth. Competition and individual power give incentives to entrepreneurs to develop new technology. Businesses compete to be the most productive, and this usually leads to the development of new technology. Unfortunately, economic growth leads to a reduction of jobs, and market economies have a difficult time fulfilling the goal of full employment. Market economies have proved to be stable. Individuals have faith in the economy because of the economic freedom they are provided. Although change is made slowly, it is made because, collectively, it is what the people want. Market economies usually accomplish the goal of economic efficiency. Capitalism encourages businesses to increase production and lower costs. An economy is efficient when it produces the most products possible at the lowest cost. A market economy promotes efficiency, but it also promotes the conservation of scarce resources. Scarce resources will be used conservatively because the scarcest resources will tend to have the highest prices. In unit 1 we learned that scarcity and utility determine value. So in a market economy, the resources that are the scarcest will have the highest price. This helps market economies conserve their scarce resources.
Some argue that market economies achieve the goal of equity because there is opportunity and motivation for all. Others argue that equity is not achieved because the poor have less economic opportunity than the rich. They argue that the children of the rich have access to better educational opportunities and better jobs. This unequal distribution of income is a weakness of the market system. Another weakness of the market system is its depletion of natural resources. Individuals in market economies are motivated by self-interest, or what will be best for them. They are not motivated by what is good for all or what is good for the environment. Air, rivers, forests, lakes, and streams belong to the society as a whole, and they tend to be used or abused without concern in a market economy.
A mixed economy is an economy that combines elements of command, market, and traditional economies. In a mixed economy, the three economic questions are answered by individuals just as in a market economy, but government agencies have a high degree of control over the factors of production and the distribution of goods and services.
One of the key strengths of a mixed economy is that consumers and businesses are protected. The economy is not governed strictly by self-interest because economic decisions are shared between the government and individuals. The individuals have economic freedom and ownership of the means of production, but the government regulates the economy. What is the purpose of these government regulations? Most of the regulations are meant to protect individuals from unfair market practices. For example, in the United States, the Federal Trade Commission is an organization run by the government to protect consumers. It enforces federal laws that prevent fraud, deception, and unfair business practices. The United States government also passes laws to ensure the protection of property rights and fair business practices.
It may sound like the best of all worlds, but the goals of efficient production, that is, responsiveness to what the consumer wants (as in a market economy), aren’t always compatible with the goals of full employment and long-term stability (command economy). A mixed economy is sometimes inefficient. The government regulations protecting the environment or fair labor practices might prevent a company from choosing the most efficient means of production. An increase in bureaucracy makes it a little more difficult to launch and maintain a business than it might be in a market economy. It is a system which strives to maintain the balance between freedom and control—two goals which are often in opposition.