What is an Economic System?
An economic
system is a means by which societies or governments organize and distribute
available resources, services, and goods across a geographic region or country.
Economic systems regulate factors of production, including capital, labor,
physical resources, and entrepreneurs. An economic system encompasses many
institutions, agencies, and other entities.
Types of Economic Systems
There are many economies around the world. Each
has its own distinguishing characteristics, although they all share some basic
features. Each economy functions based on a unique set of conditions and
assumptions. Economic systems can be categorized into four main types:
traditional economies, command economies, mixed economies, and market
economies.
1. Traditional economic system
The traditional economic system is based on
goods, services, and work, all of which follow certain established trends. It
relies a lot on people, and there is very little division of labor or
specialization. In essence, the traditional economy is very basic and the most
ancient of the four types.
Some parts of the world still function with a
traditional economic system. It is commonly found in rural settings in second-
and third-world nations, where economic activities are predominantly farming or
other traditional income-generating activities.
There are usually very few resources to share
in communities with traditional economic systems. Either few resources occur
naturally in the region or access to them is restricted in some way. Thus, the
traditional system, unlike the other three, lacks the potential to generate
a surplus.
Nevertheless, precisely because of its primitive nature, the traditional
economic system is highly sustainable. In addition, due to its small output,
there is very little wastage as compared to the other three systems.
2. Command economic system
In a command system, there is a dominant,
centralized authority – usually the government – that controls a
significant portion of the economic structure. Also known as a planned system,
the command economic system is common in communist societies since production
decisions are the preserve of the government.
If an economy enjoys access to many resources,
chances are that it may lean towards a command economic structure. In such a
case, the government comes in and exercises control over the resources.
Ideally, centralized control covers valuable resources such as gold or oil. The
people regulate other less important sectors of the economy, such as
agriculture.
In theory, the command system works very well
as long as the central authority exercises control with the general
population’s best interests in mind. However, that rarely seems to be the case.
Command economies are rigid compared to other systems. They react slowly to
change because power is centralized. That makes them vulnerable to economic
crises or emergencies, as they cannot quickly adjust to changed conditions.
3. Market economic system
Market economic systems are based on the
concept of free markets. In other words, there is very little government
interference. The government exercises little control over resources, and it
does not interfere with important segments of the economy. Instead, regulation
comes from the people and the relationship between supply
and demand.
The market economic system is mostly
theoretical. That is to say, a pure market system doesn’t really exist. Why?
Well, all economic systems are subject to some kind of interference from a
central authority. For instance, most governments enact laws that regulate fair
trade and monopolies.
From a theoretical point of view, a market
economy facilitates substantial growth. Arguably, growth is highest under a
market economic system.
A market economy’s greatest downside is that it
allows private entities to amass a lot of economic power, particularly those
who own resources of great value. The distribution of resources is not
equitable because those who succeed economically control most of them.
4. Mixed system
Mixed systems combine the characteristics of
the market and command economic systems. For this reason, mixed systems are
also known as dual systems. Sometimes the term is used to describe a market
system under strict regulatory control.
Many countries in the west follow a mixed
system. Most industries are private, while the rest, comprised primarily
of public services, are
under the control of the government.
Mixed systems are the norm globally.
Supposedly, a mixed system combines the best features of market and command
systems. However, practically speaking, mixed economies face the challenge of
finding the right balance between free markets and government control. Governments
tend to exert much more control than is necessary.
Final Word
Economic systems are grouped into traditional,
command, market, and mixed systems. Traditional systems focus on the basics of
goods, services, and work, and they are influenced by traditions and beliefs. A
centralized authority influences command systems, while a market system is
under the control of forces of demand and supply. Lastly, mixed economies are a
combination of command and market systems.
Resources
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Modeling and Valuation Analyst (FMVA)™ certification program, designed to
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To keep learning and developing your knowledge
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