economic systems (market, planned/command and mixed economic systems)

1. ECONOMIC
SYSTEMS
By Dr. Arifa Saeed

2. Definitions
• Merit goods: a commodity or service, such as education, that is regarded by society or government as
deserving public finance
• Note: actual private benefits ?
• Demerit Goods: A demerit good is defined as a good which can have a negative impact on the consumer –
but these damaging effects may be unknown or ignored by the consumer.
• Note: actual private cost ?
• Public Goods: a commodity or service that is provided without profit to all members of a society, either by
the government or by a private individual or organization
• Note: non-excludable , non-exhaustible and non-rejectable
• Private Goods: it is a product that must be purchased to be consumed, and consumption by one individual
prevents another individual from consuming it. ... Economists refer to private goods as rivalrous and
excludable.

3. THREE fundamental economic questions
• What to produce?
• Example: Does the economy need more schools or should they develop more infrastructure.
• How to produce?
• decision are based on cost, efficiency and type of product.
• Labor intensive or capital intensive technique.
• For whom to produce?
• Is the good free to everyone or should it available to only people who can pay.
• Healthcare might be free for everyone however private schools should only be for the people who can
pay.

4. economic system
• An economic system describes the way in which an economy is organized
and run, including alternative views of how resources are best allocated.
There are three main types of economic systems:
• Market Economy
• Planned Economy
• Mixed Economy

7. MARKET ECONOMY
The market economy is a system where ownership of resources in the hand of private individuals who
allocate them as they see fit and government intervention is minimized. The forces of demand & supply
are used to allocate resources and the private sector decision the answer to the three fundamental
economic questions. Its main features include:
• Private ownership
• No/less government interference
• Resources are allocated on a price basis. (PRICE MECHANISM)
• Maximizing the production of profitable products, while avoiding the production of unprofitable products. (objective or
motive profit maximization )
• Competition exists on the market, leading to greater consumer choice. (freedom of choice)
Note: The attributes are also the distribution of resources in an economy. And if there is a query about market economy resource
allocation, you can use the four points described above.

8. • The forces of demand & supply are used to allocate resources
• D = S
• D>S (shortage )
• S>D (surplus )

10. MARKET ECONOMY
Advantages
• Market economies are efficient and pay attention to
what consumers want.
• They also have freedom of choice since the
government intervention is minimized
• Market economies are driven by the profit motive
which motivates business and individuals to work
hard.
• Least interference of Govt. eliminates bureaucratic
hurdles in economic activities.
Disadvantages
• Market economies create negative externalities like noise, air
and water pollution etc. in an attempt to reduce their private costs
under their profit maximization motive.
• Market economy lacks any redistributive mechanism of
income.
• Private firms under profit maximization will produce demerit
goods. Deposits goods are bad of society like Alcohol, cigarette
etc.
• Due to absence of government control public goods such as
street lighting, roads, healthcare might not be provided.
• Due to competition firms tend to waste valuable resources on
activities like excessive advertising to gain competitive advantage.
This also leads to consumer exploitation

11. Planned Economy
• A planned economy is where all the resources are allocated by the
government. They use a rationing mechanism of central planning and
quotas. The aim in planned economy is collective social welfare. Features
include:
• Basic economic questions answered by the government.
• Wage differentials are minimal due to the aim of quality and eliminating social gap.
• There is minimal engagement in international trade as the government prefers to be
self-sufficient.

13. Planned Economy
Advantages
• There is a large potential for economies of scale by
operating large state monopolies like water supply, public
transport, electricity.
• Due to absence of competition wastage can be reduced.
Since costs of advertisement will be nonexistent and
state will only provide goods that are necessary which
will lead to less wastage of scarce resource.
• The gap between rich and poor is minimized
• The government keep on externalities like pollution and
reduce the production of demerit goods like alcohol,
cigarettes etc.
Disadvantages
• Due to absence of price mechanism the
government is unable to guess exact
quantities demands which can lead to
surplus and shortages in the economy.
• There is a lack of variety of goods which
reduces the standard of living.
• The economy is less responsive to
consumer needs.

15. MIXED ECONOMY
• A mixed economy is a combination of both market and planned economy. Main
features include:
• The degree of private and public involvement is determined by the government.
• Essential services like health education street lighting public transport is provided by the
public sector. The private sector provides goods and services demanded by the consumers
like cars, entertainment, tourism etc.
• This is a good system since is strikes a balance between both the worlds, however it should
always be noted that even in a mixed economy consumers sometimes have to pay high prices
if there are private monopolies and public sector is prone to inefficiency.

16. Features Market economy Command economy Mixed economy
Ownership of property Private ownership Government ownership Private + Public
Motive or objective Profit maximization Collective social welfare Both
Allocative mechanism Price mechanism
(D and S)
Rationing mechanism
(Centrally planned quotas)
Both
Freedom of choice Yes No Both
Competition Yes No Both
The role of Govt. No Yes Both
Variety of goods & services Yes No Both
Quality of goods & services High quality Usually poor quality Both
Response to change in
demand
Quick response to change in
consumer preferance
Slow or No response Both
Efficiency Efficient Inefficient both

17. Features Market economy Command economy Mixed economy
Shortage & surplus
D>S= shortage
S>D= surplus
Due price mechanism, the
market is clear i.e. no
shortage n no surplus
Central planning is unable to
guess exact quantities
demanded so possibility of
shortage n surplus
both
Merit good (e.g education n
health)
Under-production and
under-consumption
Yes Both
Public good (e.g. street
lights, national defense, etc.)
Missing Provide them through
governmental expenditure.
Both
Demerit good (e.g. drugs,
etc.)
over-production and over-
consumption
Fewer or no demerit goods Both
Distribution of income and
wealth
Unequal income or wealth
distribution
Even distribution Both
Efficiency Efficient Inefficient both