Principles of Economics/Economic Systems
Economics deals with the fundamental questions of why people produce, what they produce, and how much they produce. While one economy may depend on rice, another may need wheat to sustain its economy. Since goods do not stay in the possession of one person but are constantly created and consumed, the system by which goods move is very important to all consumers. There are two extremes of economic systems: Planned Economies and Market Economies. Although a topic in macroeconomics, a quick overview of these two terms is helpful in understanding the bigger picture behind microeconomics.
A pure planned economy has one person or group who controls what is produced; all businesses work together to produce goods and services that are planned and distributed by the government. These economies are also called Command Economies because everyone must follow specific guidelines set up by the government. The reason behind such an economy is to make sure that everything needed is produced and that everyone's needs are fulfilled. The main drawback of planned economies is that those who plan the economy must know exactly what should be produced and in what quantities; otherwise, people will not be able to buy as much as they need and shortages will occur.
Planned economies have several advantages. Ideally, there is no unemployment, and needs never go unfulfilled; because the government knows how much food, medicine, and other goods is needed, it can produce enough for all. Realistically, however, these systems tend to suffer from large inefficiencies and are overall not as successful as other types of economic systems.
A pure market economy is one perfectly free of external control. Individuals are left up to themselves to decide what to produce, who to work for, and how to get the things they need. This type of economy, though it may be chaotic at times, allows people to change along with the shifting market conditions to maximize their profits.
Although avoiding many of the inadequacies of planned economies, market economies are not free of their own problems and downfalls. Perhaps the greatest problem is that business firms may refuse to produce goods that is unprofitable for them. For instance, in 2000 there was a shortage of tetanus vaccine in the United States; one of the two companies that had previously made it went bankrupt. Because it was expensive to make, other companies were unwilling to start production themselves, leaving only one firm struggling to keep up with demand. In a planned economy, this shortage would not happen because the government would boost production of the vaccine if it were needed.
Because there is no regulation ensuring equality and fairness, market economies are burdened with unemployment, and even those with jobs can never be certain that they will make enough to provide for all of their needs. Despite these and other problems, market economies come with many advantages, chief among which is speed. Because they do not need to wait for word from the government before changing their output, companies under market economies can quickly keep up with fluctuations in the economy, tending to be more efficient than regulated markets. Also, individuals have more freedom and opportunities to do the jobs they want and to profit by them.
Most modern economies do not strictly follow either system but, wanting the benefits from both systems, will instead have some combination of the two. Usually they have a mostly free market, with the government owning some businesses and providing some goods and services to the citizens. Some governments may subsidize industries, rather than actually own them. When a government subsidizes an industry, it provides benefits such as tax breaks, so that the industry will remain profitable. Similarly, mixed governments may have government-owned hospitals and medical services for public use but allow other parts of the economy to run on their own to avoid inefficiency.
In any economy that is not completely planned, there are markets for some, or all, goods and services. These markets are where everything we study in microeconomics occurs. In a pure free-market economy, all goods and services may be bought and sold, whereas in some mixed economies, certain goods are regulated by the government. In either case, the way a good is bought and sold depends on how scarce it is, who supplies it, and what the consumer wants to do with it. In the next chapter, we will start to examine the way markets work.
- Identify one or more countries which demonstrate each of the three main economic types: planned, market, and mixed.
- Why are most modern economies mixed?
- What type of goods would a country not want to have a market for? Why?