What do we mean by “types” of economic systems?
Economic systems are the mechanisms used by societies to answer the basic economic questions such as:
1. What goods are to be produced?
2. How to produce these goods? That is, what production technique should be used in the creation of the desired goods? And what specifications should be incorporated into the product? For whom to produce? That is, for which group of individuals are the goods to be produced for & distributed to?
How much to produce? How much of a good should be produced & supplied to society?
At what price should a good be supplied or sold?
Types of Economic Systems
There are 4 basic types of economic systems which can be adopted by societies to answer the production questions.
2 of the 4 systems are polar opposites of each other:
“Free market” economy (capitalism) vs.
“Planned” economy (socialism)
Types of Economic Systems
The other 2 systems lie somewhere in-between the “market” and “planned” systems. They are the:
Some industries are owned or controlled by government while the rest is controlled by private individuals or the private sector.
Indicative planning economy
Government is market-friendly and encourages private enterprise, but will “tweak” market outcomes to support its industrial policy.
Economic Systems Differ Along 3 Dimensions
Decision-making: Who controls/owns the resources? Government? Private Sector? Or both?
System of incentives used to motivate individuals
Material incentives Moral Persuasion Coercion
Nature and extent of individual rights
Freedom of mobility & employment
Ownership rights – or the right to own assets.
Private Property Rights: a) control rights b) cash-flow rights c) disposal rights d) access to legal recourse if private property is stolen, confiscated, vandalized or damaged. 1. Decision-Making: Who Decides? Who decides what to produce, how to produce, for whom to produce, how much… and at what price?
In a free market, capitalist economy, decision- making is decentralized down to the level of the private individual, and across all of the households and businesses within the economy.
In a planned or socialist/communist economy, decision-making is centralized or under the control of government “central planners” or a “central planning authority.”
Decision-making: Who decides?
In a mixed economy, government controls some of the resources and industries, while the private sector controls the rest. Government decides how to use the resources it controls… in turn, the private sector decides how to use the resources it controls.
In an indicative planning economy, the government believes in private ownership, so enterprises are “privately-owned”. However, the government has an industrial policy with “vision.” It targets certain industries for rapid growth & expansion and then “woos” business leaders into reallocating their assets into these industries. There is no coercion involved. The wooing of businesses is based on an uncoerced, voluntary consensus between the business leaders and government.
Measuring differences among economic systems
Ways of classifying and measuring the economic performance of economies
1. Degree of Economic Freedom
The economic freedom index assesses how “free” a society is from government involvement or control over the economy.
The freedom index number is computed by assessing the performance of the economy on each of the following 10 dimensions.
1. Trade policy 6. Banking policy
2. Taxation policy 7. Wage and price controls
3. Government spending 8. Property rights
4. Monetary policy 9. Regulation policy
5. Foreign investment & capital flows…