Economic System

An economic system refers to the organizational arrangements and process through which a society makes its production and consumption decisions. Whenever a society chooses an economic system, it chooses among alternative objectives and alternative decision modes. The objectives may be efficiency, growth, equality , liberty.

 In other words, it is the structure of production, allocation of resources, distribution of economic outputs and consumption of goods and services in an economy. It is a set of institutions and their social relations. It is composed of people and institutions.

The contemporary economic systems are Capitalist System Socialist System Mixed Economy Economic system is the study related to the economics of the respective system.

Dimensions of an Economic System

1. Decision-Making Structure: How decisions are made regarding the use of economic inputs , distribution of output, the level of centralization in decision-making, and who makes these decisions. Decisions may be taken by industrial councils, government agency or private owners.

 2. Coordination Mechanism: How information is obtained and used to coordinate economic activity. The two popular forms of coordination mechanism are planning or markets.

 3. Productive Property Rights: This refers to the ownership and control of the factors of production. The factors of production may be held by public or private.

 4. Incentive System: it is a mechanism to urge the members to engage in productive activity. The rewards may be in material form or moral form.

Basic Types of Economic Systems

The various types of basic economic systems are : 1. market Economy : is an economy based on the power of division of labor in which the prices of goods and services are determined in a free price system set by supply and demand.

 2.Planned Economy : is an economic system in which the state directs the economy. The state controls the industry in such a way that the major decisions regarding production and distribution of goods and services are taken by the central government.

 3. Mixed Economy: is an economy that includes a variety of private and public control that are a reflection of both characteristics of capitalism and socialism. There is a degree of private economic freedom with a degree of governmental regulations. It also includes some state ownership of factors of production for social and national cause.

 4. Traditional Economy: in this type of economy, the decision making is mainly based on tradition and customs. This is the term used to describe societies which are primarily dependent on agriculture. In this type of economy, every member of the society has a job.

 5. Participatory Economies: It uses participatory decision making as an economic mechanism to guide the production, consumption and allocation of resources in a given society. This is a sort of socialism a the decision making and ownership lies with the workers

 6. Gift Economy: is a society where valuable goods and services are regularly given without any explicit agreement for immediate or future rewards. 7. Barter Economy: is a method of exchange by which goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money.

Laissez - faire
In economics, laissez faire means an environment in which the transactions between private parties take place without state intervention like tariffs, laws, taxes etc. This economic system provides complete freedom to enterprises in production , distribution and consumption of goods in a society. The business policies of a firm are driven by the market forces. This system assumes that the individual who pursues his own desires contributes most successfully to the society as a whole.

 This system was promoted by the physiocrats those who believed in the rule of nature and believed that the written law should be in harmony with the law of nature. The physiocrats believed that all wealth originated with the land and that agriculture alone could increase and multiply wealth. This system lost its popularity with industrialization as it could not deal with the social and economic problems caused by industrialization.

 The main drawback of this system is that it could result in the undesirable growth of undesirable sectors at the expense of essential sectors.

Capitalism or Market economy

Market economy is an economic system that operates in a free market and is not planned or controlled by a central authority. This type of economic system is only theoretically possible because it excludes taxation and regulation of any kind. Capitalism comes closest to this system.

 Capitalism is an economic system in which the means of production are privately owned and operated for a private profit. Decisions regarding supply, demand, price, distribution, and investments are made by private actors in the free market. Profit is sent to owners who invest in businesses, and wages are paid to workers employed by businesses and companies.

 Capitalism does not presuppose a specific form of political or social organization. It can exist under democracy, communism and even dictatorship. The essential requirement is that in capitalism, out of the three factors of production land, capital and labor the land and capital are privately owned and are used to generate private profit or exchange value.

 There are many variants of capitalism. Some of them are: 1.Anarcho- Capitalism : in this form of capitalism, the state is completely eliminated and the individual is sovereign individual. In this form, the law enforcement and security is provided by voluntarily funded dispute resolution organizations and privately owned security agencies.

 2. Mercantilism: this uses the state to advance national business interests abroad, and holds that the wealth of a nation is increased through a positive balance of trade with other nations. 3. Free market capitalism or laissez-faire. 4. Mixed economy

 5.Social market economy: here the government intervention in price formation is kept to a minimum, but the state provides for moderate to extensive provision of social security, unemployment benefits and recognition of labor rights through national collective bargaining schemes.

 6. State Capitalism: consists of stateownership of profit-seeking enterprises that operate in a capitalist manner in a market economy. 7. Corporate Capitalism: is a free or mixed market characterized by the dominance of hierarchical, bureaucratic corporations, which are legally required to pursue profit.

Features of a Pure Capitalist Economy

1. Private Ownership: The factors of production like land, labor and capital are privately owned and production occurs at private initiative. Individuals are free to use their property as they wish. The property rights are protected , enforced and controlled by law.

 2. Free Enterprise: The private firms are free to obtain resources, organize production and sell the product without any governmental or other restriction. 3. Consumers Sovereignty: The consumers have complete freedom of consumption. 4. Freedom of Choice of Occupation: The individual is free to pursue any occupation of his choice.

 5. Freedom to save and Invest: This feature is related to the freedom of consumption as saving depends upon income and consumption. This freedom is supported by the freedom to inherit , accumulate and transmit wealth. 6. The market system: The market mechanism is the key factor that regulates the capitalist economy. The buyers and sellers express their opinions about products and services through their willingness to buy or sell a product at a particular price.

 7. Competition: This is an essential feature of the capitalist economy. Competition reduces market imperfections and associated problems. Competition also ensures that the production and distribution process is regulated by market forces. It gives a boost to initiative, protects the consumers and mantains flexibility in the price system.

 8. Absence of a central Plan: Since in a capitalist economy thee is freedom of enterprise, occupation and property rights, there is a total absence of central plan. Resource allocation and investment are guided by market forces and not central plan.

 9. Limited Government role: In a capitalist economy, the government role is limited to the extent of ensuring smooth functioning of the capitalist system. Government role is necessary in such functions as defining property rights, enforcing contractual agreements etc.

 The capitalist economies described above are hardly found in the real world. Instead, in todays world, we find modern capitalist economies which are regulated capitalist systems. In these type of modern capitalist economies, a considerable share of nations produce goes to satisfy public wants, a substantial part of private wealth is generated through public budget and the private income distribution is influenced by tax and transfer payments.

 The budget also affects the level of employment and prices in private sector. In the opinion of Musgraves, market mechanism alone cannot perform all the economic functions. Public policy is required to guide , correct and supplement it in certain respects.

 A proper size of public sector is necessary because : - the contractual arrangements and exchanges required for market exchanges require govt. protection. - in order that the market mechanism works smoothly , the consumers and the producers must have full knowledge and there must be no entry barriers. This can be ensured only by government regulations.

 - The production and consumption characteristics of certain goods is such that these cannot be provided for through the markets. These require solution through the public sector. - the market system does not necessarily bring employment, price stability and socially desired rate of growth. Public policy is required to achieve these objectives.

Merits and demerits of capitalism

Merits: 1. Automatic functioning. 2. Greater efficiency and incentive to work. 3. Higher rate of capital formation and growth. 4. Economic development and prosperity. 5. Optimum utilization of resources. 6. A just system of reward and penalty 7. Democratic System 8. Adaptability 9. Encouragement to enterprise and risk taking.

Demerits: 1. Excessively materialistic 2. Not as productive as other economic systems. 3. Gives rise to class conflict 4. Social injustice and economic inequality. 5. Ignores human welfare. 6. Periodic economic instability and unemployment. 7. Precedence of property rights over human rights. 8. Emergence of monopolies. 9.Misallocation of resources.