What is an economic system in which the government owns some factors of production and has a role in determining what and how goods are produced?

Have you ever heard the phrase, “you can buy almost anything online!”? It stands as a simple reminder that everything, in some capacity, will be owned. An economic system is the way society determines who will own things and how that ownership will be decided.

All societies must answer three questions. The answers they select determine what type of economy, or economic system, the society primarily has a command or market economy. The three questions are:

1. What should we produce?
2. How should we produce?
3. For whom should we produce?

A free market system answers the questions in the following way:

1. BUYERS decide what will be produced.
2. SELLERS decide how to produce.
3. MONEY determines who gets the goods and services.

As buyers purchase goods and services, they signal to the producers what ought to be made.  If people want to wear pants with farm animal designs, they buy them. Producers have to be observant to anticipate demand. As they see that the stock of cow pants is flying off the shelves, they will create many more of them. Buyers and sellers are able to communicate effectively using just money. No one has to send emails to the company to ask for more pants with sheep designs; the fact that the pants sell quickly sends the message quickly. Likewise, when people move away from barnyard fashions and don’t buy them anymore, producers know to slow or stop production based merely on sales. Again, no one calls the company to request fewer pairs of chicken pants.  Money talks, as they say, so buyers decide what will be produced. The producer of the good or service selects the best, most profitable way to produce. They use the factors of production—land, labor, capital, and entrepreneurship—to maximize goals of the company.  Finally, to establish distribution of the good or service, price is used. In market economies, when consumers want anything from food to dental services to a new hat, they need only go to the correct place and give enough money to fulfill the price requirement.

A purely free market economy has several important characteristics. The first requirement is great freedom to buy and sell goods and services to satisfy one’s own desires. Individuals are responsible for making their own decisions regarding if, where, and how hard to work.

The father of economics, Adam Smith, wrote in The Wealth of Nations, “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest” (Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776).

By producing items of value to others, people will in turn help themselves.

A purely free market is not devoid of government. Rather, the government has a limited, small, and important role to play in the economy: protection of private property might require a lot from government in certain conditions. The ownership of factors of production as well as finished goods and services relies on clearly-defined and well-enforced property rights. We have paperwork like receipts, ownership titles, and deeds to prove that we own things. We are able to enjoy all the privileges that go along with ownership, including the right to sell the objects.

If property rights are threatened, the police and court system get involved to solve problems.

That role for government, while critical, is small. There are no public goods such as roads, streetlights, or public parks provided under a purely free market. There also exists no governmental safety net. People who are permanently or temporarily unemployed or disabled receive no government assistance. In this scenario, private individuals, civil organizations, or businesses must provide these goods and services.

On the opposite side of the spectrum is a command, or socialist, economy (Cuba, India, and North Korea). In these countries, central planners make decisions about what, how, and for whom to produce. Using complex computer models, government workers make output and supply decisions and businesses fulfill orders.

In a command economy, the government owns the factors of production; all decisions about land, labor, and capital are made by the state. Bureaucrats analyze enormous sets of data about current stock levels, predicted demand, and availability of resources. They determine output plans which are checked and sometimes adjusted at lower levels by regional directors and company managers. Orders are set, supplies ordered, and then the workers need only fulfill the job. Since the government planners also get to determine what individuals’ occupations are, they can effectively command the entire economy. Once the good or service is created, the price is also set by the government planners. The overall goal is equity. By having fair prices and wages that are set by the government, all of society will have needs met, and there will not be a division between rich and poor people.

The logic of a command system has been described in this way: “experts would plan, zealots would compete in zeal, technology would tame nature, labor would make free, the benefits would accrue to all.  From each according to his ability; to each according to his deserts; and eventually, to each according to his needs” (David Landes, The Wealth and Poverty of Nations: Why Some Are So Rich and Some Are So Poor, 1998).

There are many problems with a command system. Perhaps the most stifling problem is the lack of freedom resulting from the coercion needed to make a command economy function. In a command economy, the state is the coercive force that determines many facets of individuals’ lives, including what job to work, where to live, and what and how many goods and services are available. The command system is also encumbered by the vast amount of information needed to properly make production decisions for an entire country. It is invariably beyond the scope of planners to comprehend. In terms of the nation’s productivity, the incentives to work hard or invent new products do not exist. This coercive system results in major inefficiencies. Without rewards for hard work, people naturally complete just the bare minimum required. For example, China transitioned its agricultural sector from pure command to more of a market-based system between 1978 and 1984. Over that time, total agricultural production increased by 42 percent as farmers were able to keep, use, and sell any crops above the government’s quota (Justin Yifu Lin, “Rural Reforms and Agricultural Growth in China,” American Economic Review, 1992). The market-based transition gave famers incentives to work hard and improve what they do to utilize fertilizers and other machinery helpful in producing crops. The reality of a command system is that production decreases and with it, overall happiness decreases.

This loss of freedom and happiness is the opportunity cost of coercion.

In reality, there is no such thing as an economy that is only market or only command. Rather, all systems are mixed models and fit along a spectrum. The United States is primarily market-based, but the government plays a role, too. The government provides a social safety net. In 2011, the United States spent over $2 trillion (13.5 percent of the overall GDP) on Social Security, Medicaid, Medicare, and other social services like unemployment compensation. There is also the extensive regulation of the economy with policies about the environment, working conditions, taxes, and subsidies.

Likewise, there is no economy that is purely command.  Features of a market system exist, sometimes legally and sometimes illegally.  In North Korea, one of the most centrally-planned economies in the world, the government allowed for some market reforms in agriculture, creating the possibility of farmers’ markets to emerge.  In Cuba, the underground economy is said to be so vast that 95 percent of the population buys and sells goods illegally (Paul Haven Paul, “Cuba’s Shadow Economy Sees Some Daylight”, The Washington Times, 2011).

Examining the type of economic system gives great insight to how governments of countries function.  Market-based systems allow for more individual freedom and thus, less government control. Governments in command-based systems must be more heavy-handed, affecting the day-to-day lives of citizens in a much greater capacity.

Have you ever thought about how our society functions? How do certain decisions get made and who gets to make them? To be able to answer those questions, you have to know about economic systems. They are the foundation for sorting out how to handle resources and production. To learn about economic systems, their functions, types, and more, read on!

Economic Systems Definition

An economic system is a way for communities or governments to manage and efficiently disperse resources, services, and products. It governs elements such as land, currency and labor. It also consists of multiple organizations, institutions, decision-making procedures, and consumer habits that make up the framework of a specific society.

An economic system is a way for communities or governments to manage and efficiently disperse resources, services, and products.

Economic Systems Overview

Nations all around the world use economic systems to allocate resources and exchange products and services. The purpose of them is to manage the four production components, which are labor, capital, entrepreneurs, and material assets. Simply put, these production factors include a company's personnel and finances, along with connections to entrepreneurs. Resources required to operate a firm, as well as the data and information used by businesses to succeed, are all necessary components. The way the resources will be handled and which production components that will be used all depend on the type of economic system a society has.

There are four main types of economic systems:

• Command
• Market
• Mixed
• Traditional

Entrepreneurs are people who wish to manage enterprises or establish their own businesses.

Functions of an Economic System

There are four main functions of an economic system, and the answers will determine what type of system the society has:

• What to produce?
• How much to produce?
• How to produce?
• Who gets what?

What to produce?

The most essential job of an economy is to determine what commodities and services will be produced. And while demands are limitless, resources are not. As a result, society is confronted with the challenge of selection.

One of the first things that society then has to figure out is what to produce. The provided resources are used to produce various items and services in order to satisfy the greatest number of consumer desires. Therefore, the community must choose between consumer and capital products.

Things become a bit more complicated when talking about consumer goods since a choice must be made between products for general consumption and those for luxury.

How much to produce?

Should production be at maximum potential or should there be some jobless people and wasted resources? How much to manufacture is governed by customer demand; unless someone purchases a particular item, manufacturing of that item would stop and a surplus would accumulate.

How to produce?

The next main issue to tackle is the issue of how to produce. In order to help figure out the answer, there are a few things that are taken into account before making a decision:

• Which commodities will be manufactured in the public vs private sector?

• Which companies will be hired on to produce the commodities, and how many resources will be given to them to use for production?

• Which manufacturing methodologies will be adopted to ensure maximum output?

The community should adopt a style of production organization that can adequately meet the greatest number of people's desires.

Who gets what?

The allocation of output in society is another critical role of an economic system. The following criteria must be examined in order to ensure an equitable and efficient allocation of production.

• How output is allocated between households and the government.

• The ideals of fairness and efficiency

In a capitalist system, for example, allocation is done via the pricing mechanism, which produces disparities. Because of this, income plays a large role in who gets what.

Capitalism is an economic system wherein individuals own and manage property in accordance with their desires, and free market forces establish prices in a way that fits society's best interests.

The pricing mechanism is the method through which the market forces of supply and demand determine commodity prices.

Economic systems are classified into four kinds. Each method has advantages and disadvantages.

Command Economic System

The essential economic choices in command economies are made by the governments. The government decides which commodities will be produced, as well as the pricing and pay rate. Farms and companies are owned by the government instead of the people. Laborers are instructed on what and how much to create. They are assigned a production goal to accomplish and are expected to accomplish it. The decision of what has to be manufactured is a challenge in a command economy.

Command economy is an economy where the government controls what commodities are produced, the pricing of items, what services will be available, and the incomes of laborers. This type of economy is usually seen in communist regimes.

One advantage is that costs are fixed and consumers know how much everything will cost. However, it doesn't create the perfect society for a few reasons. For example, the production of commodities isn't always in sync with demand, and substandard management of the commodities frequently results in rationing. Also, professionals are valued for obeying orders instead of taking chances, which discourages innovation.

An example of a command economy today would be North Korea.

Check out our explanation of Command Economy to learn more!

Market Economic System

Decision-making in a market economy is dictated by price fluctuations that happen between producers and consumers. Individuals and companies own companies and farms. Each company or farm determines what they wish to create.

Also referred to as capitalism or laissez-faire economies, market economies are economic systems wherein market decisions are governed by price fluctuations that occur when sellers and consumers interact to set the sale of products.

The amount individuals pay for items is determined by supply and demand. The amount of commodities available is known as supply, while the number of people that desire the items is known as demand. One advantage to this type of economy is that buyers are able to locate what they want and purchase as many of the items as they want and can finance. An issue is that there is no pricing stability, and enterprises that are mishandled can fail. Workers could lose their employment and salaries if this occurs.

Singapore is a good example of a market economy.

Supply is the amount of commodities available

Demand is the number of people that desire the commodities

We also have an explanation of Market Economy. Cool, huh?

Mixed Economic System

A mixed economy combines elements of command and market economies. All of the societies present-day have features of both systems and are frequently called mixed economies, despite the fact that almost all societies tend to learn toward one form of economy than the other.

A mixed economy is an economy that combines parts of command and market economies

It also reduces the drawbacks of market economies. A market economy may overlook industries such as military and tech. A greater government involvement enables a faster response speed to these key sectors.

The increasing government involvement also ensures that less competitive individuals are looked after. This eliminates one of the drawbacks of a market economy, which favors only the most successful or inventive. However, in a mixed economy, the individuals who are unable to compete at all are still left out.

A country that has a mixed economy would be the United States.

We are three for three! Explanation of Mixed Economy here!

With traditional economies, historical norms and habits govern what and how things are created, distributed, and spent. Every individual within this society understands their place in the greater group. Because occupations are handed down through generations, there is minimal change in professions over time. People are counted on to do their work and the entire society can collapse if people neglect to do their share. This type of economy includes hunting, farming, etc. Furthermore, in traditional economies, bartering is utilized for business.

The country of Bhutan is a prime example of a traditional economy.

A traditional economy is an economy where historical norms and habits govern what and how things are created, distributed, and spent

Bartering is trade without the use of actual money

Forms of Bartering

As far as bartering is concerned, many people think it to be something medieval and old-school. But bartering happens all over the world still today! Temporary home swaps, social media influencers getting free products from a company to review the products and advertise them, and even in some cases marriage are examples of bartering!

But how, you might ask, is marriage a type of bartering? If you want to think more of a "traditional" marriage that was prevalent many decades ago like in the figure above, a marriage was an exchange between a man and a woman where the woman would get someone to see to her safety (both physical and financial), and perhaps a title or even just the privilege of marrying into a well-connected family. The man, on the other hand, would receive children from the woman in exchange so he can carry on the family line.

To give an example of an economic system in action, you don't need to look further than the United States.

The United States has a mixed economy, which includes components of the command and market economies. Regarding consumer products and corporate services, the U.S. economy works as a free market. But in terms of military, it resembles a command economy. The government supervises these activities and defends the nation's diversified economic structure. Work and natural resources are examples of supply, whereas demand is exemplified by human consumption.

Economic Systems - Key takeaways

• An economic system is a way for communities or governments to manage and efficiently disperse resources, services, and products.
• Nations all around the world use economic systems to allocate resources and exchange products and services.
• There are four kinds of economic systems: command, market, mixed, and traditional.
• Bartering is trade without the use of actual money.
• The most essential job of an economy is to determine what commodities and services will be produced.