1. Traditional Economic System
The traditional economic system is the most traditional and ancient types of economies in the world. Vast portions of the world still function under a traditional economic system. These areas tend to be rural, second- or third-world, and closely tied to the land, usually through farming. In general, in this type of economic system, a surplus would be rare. Each member of a traditional economy has a more specific and pronounced role, and these societies tend to be very close-knit and socially satisfied. However, they do lack access to technology and advanced medicine.
2. Command Economic System
In a command economic system, a large part of the economic system is controlled by a centralized power. For example, in the USSR most decisions were made by the central government. This type of economy was the core of the communist philosophy.
Since the government is such a central feature of the economy, it is often involved in everything from planning to redistributing resources. A command economy is capable of creating a healthy supply of its resources, and it rewards its people with affordable prices. This capability also means that the government usually owns all the critical industries like utilities, aviation, and railroad.
In a command economy, it is theoretically possible for the government to create enough jobs and provide goods and services at an affordable rate. However, in reality, most command economies tend to focus on the most valuable resources like oil.
China or D.P.R.K. (North Korea) are examples of command economies.
Advantages of Command Economic Systems
- If executed correctly, the government can mobilize resources on a massive scale. This mobility can provide jobs for almost all of the citizens.
- The government can focus on the good of society rather than an individual. This focus could lead to a more efficient use of resources.
Disadvantages of Command Economic Systems
- It is hard for central planners to provide for everyone’s needs. This challenge forces the government to ration because it cannot calculate demand since it sets prices.
- There is a lack of innovation since there is no need to take any risk. Workers are also forced to pursue jobs the government deems fit.
3. Market Economic System
In a free market economy, firms and households act in self-interest to determine how resources get allocated, what goods get produced and who buys the goods. This is opposite to how a command economy works, where the central government gets to keep the profits.
There is no government intervention in a pure market economy (“laissez-faire“). However, no truly free market economy exists in the world. For example, while America is a capitalist nation, our government still regulates (or attempts to control) fair trade, government programs, honest business, monopolies, etc.
In this type of economy, there is a separation of the government and the market. This separation prevents the government from becoming too powerful and keeps their interests aligned with that of the markets.
Historically, Hong Kong is considered an example of a free market society.
Advantages of a Free Market Economy
- Consumers pay the highest price they want to, and businesses only produce profitable goods and services. There is a lot of incentive for entrepreneurship.
- This competition for resources leads to the most efficient use of the factors of production since businesses are very competitive.
- Businesses invest heavily in research and development. There is an incentive for constant innovation as companies compete to provide better products for consumers.
Disadvantages of a Free Market Economy
- Due to the fiercely competitive nature of a free market, businesses will not care for the disadvantaged like the elderly or disabled. This lack of focus on societal benefit leads to higher income inequality.
- Since the market is driven solely by self-interest, economic needs have a priority over social and human needs like providing healthcare for the poor. Consumers can also be exploited by monopolies.
4. Mixed Economic System
A mixed economy is a combination of different types of economic systems. This economic system is a cross between a market economy and command economy. In the most common types of mixed economies, the market is more or less free of government ownership except for a few key areas like transportation or sensitive industries like defense and railroad.
However, the government is also usually involved in the regulation of private businesses. The idea behind a mixed economy was to use the best of both worlds – incorporate policies that are socialist and capitalist.
To a certain extent, most countries have a mixed economic system. For example, India and France are mixed economies.
Advantages of Mixed Economies
- There is less government intervention than a command economy. This results in private businesses that can run more efficiently and cut costs down than a government entity might.
- The government can intervene to correct market failures. For example, most governments will come in and break up large companies if they abuse monopoly power. Another example could be the taxation of harmful products like cigarettes to reduce a negative externality of consumption.
- Governments can create safety net programs like healthcare or social security.
- In a mixed economy, governments can use taxation policies to redistribute income and reduce inequality.
Disadvantages of Mixed Economies
- There are criticisms from both sides arguing that sometimes there is too much government intervention, and sometimes there isn’t enough.
- A common problem is that the state run industries are often subsidized by the government and run into large debts because they are uncompetitive.
Economic Growth And Development
What is the difference between Economic Growth and Development? We will start by defining Economic growth and development. Having economic growth without economic development is possible.
Economic growth in an economy is demonstrated by an outward shift in its Production Possibility Curve (PPC). Another way to define growth is the increase in a country’s total output or Gross Domestic Product (GDP). It is the increase in a country’s production.
A country’s economic development is usually indicated by an increase in citizens’ quality of life. ‘Quality of life’ is often measured using the Human Development Index, which is an economic model that considers intrinsic personal factors not considered in economic growth, such as literacy rates, life expectancy and poverty rates.
Growth Occurs When
- There is a discovery of new mineral/metal deposits.
- There is an increase in the number of people in the workforce or the quality of the workforce improves. Example: training and education.
- There is an increase in capital and machinery.
- There is an improvement in technology.
Development Occurs When
Measures of economic development will look at:
- An increase in real income per head – GDP per capita.
- The increase in levels of literacy and education standards.
- Improvement in the quality and availability of housing.
- Improvement in levels of environmental standards.
- Increased life expectancy.
Difference between Economic Growth and Economic Development
We can also have a situation where there is growth and development, i.e. increase in luxury goods and education.
Development alleviates people from low standards of living into proper employment with suitable shelter. Economic Growth does not take into account the depletion of natural resources which might lead to pollution, congestion & disease. Development, however, is concerned with sustainability which means meeting the needs of the present without compromising future needs.
A. Economic Growth
Growth is an increase in the country’s output.
Development is an improvement in factors such as health, education, literacy rates and a decline in poverty levels.
The Relationship between Inequality and Economic Growth
Poverty has come down most when inequality has fallen, and there is high economic growth. Initial low levels of inequality are associated with more negative elasticities of poverty reduction concerning growth. Higher initial inequality results in less effect on poverty with an increase in economic growth.
1. Savings rate
The marginal savings rate changes with decreasing or increasing income. The marginal savings rate is the fractional decrease in saving that results from a decrease in income.
2. Credit market constraints
The poor can’t get loans.
3. Political economy
Governments pursue poor policies (redistribution policies) trying to reduce inequality which results in high inflation, high deficit, and lower growth. However, there doesn’t seem to any relationship between inequality and economic growth empirically. But, higher economic growth leads to lower levels of poverty (not the same as inequality)
The positive growth of people’s income and no change in income leads to a decrease in the poverty level.
If there is a rise in inequality and mean income remains constant, then poverty will rise.
The 4 Types Of Economic Systems Explained
There are four primary types of economic systems in the world: traditional, command, market and mixed. Each economy has its strengths and weaknesses, its sub-economies and tendencies, and, of course, a troubled history.
Below we examine each system in turn and give ample attention to the attributes listed above. It’s important to understand how different parts of the world function economically, as the economy is one of the strongest forces when it comes to balancing political power, instigating war and delivering a high (or low) quality of life to the people it serves. Anyone interested in economics on a global level should check out this fantastic course on the crisis of capitalism and why the global economy is teetering on the verge of collapse.
1. Traditional Economic System
A traditional economic system is the best place to start because it is, quite literally, the most traditional and ancient type of economy in the world. There are certain elements of a traditional economy that those in more advanced economies, such as Mixed, would like to see return to prominence.
Where Tradition Is Cherished: Traditional economies still produce products and services that are a direct result of their beliefs, customs, traditions, religions, etc. Vast portions of the world still function under a traditional economic system. These areas tend to be rural, second- or third-world, and closely tied to the land, usually through farming. However, there is an increasingly small population of nomadic peoples, and while their economies are certainly traditional, they often interact with other economies in order to sell, trade, barter, etc. Learn about the complexities of globalization and how it shapes economic relationships and affects cultures with this great class on the geography of globalization.
Minimal Waste: Traditional economies would never, ever, in a million years see the type of profit or surplus that results from a market or mixed economy. In general, surplus is a rare thing. A third-world and/or indigenous country does not have the resources necessary (or if they do, they are controlled by wealthier economies, often by force), and in many cases any surplus is either distributed, wasted, or paid to some authority that has been given power.
Advantages And Disadvantages: Certainly one of the most obvious advantages is that tradition and custom is preserved while it is virtually non-existant in market/mixed economies. There is also the fact that each member of a traditional economy has a more specific and pronounced role, and these societies are often very close-knit and socially satisfied. The main disadvantage is that traditional economies do not enjoy the things other economies take for granted: Western medicine, centralized utilities, technology, etc. But as anyone in America can attest, these things do not guarantee happiness, peace, social or, most ironically of all, economic stability.
2. Command Economic System
In terms of economic advancement, the command economic system is the next step up from a traditional economy. This by no means indicates that it is fairer or an exact improvement; there are many things fundamentally wrong with a command economy.
Centralized Control: The most notable feature of a command economy is that a large part of the economic system is controlled by a centralized power; often, a federal government. This kind of economy tends to develop when a country finds itself in possession of a very large amount of valuable resource(s). The government then steps in and regulates the resource(s). Often the government will own everything involved in the industrial process, from the equipment to the facilities.
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Supposed Advantages: You can see how this kind of economy would, over time, create unrest among the general population. But there are actually several potential advantages, as long as the government uses intelligent regulations. First of all, a command economy is capable of creating a healthy supply of its own resources and it generally rewards its own people with affordable prices (but because it is ultimately regulated by the government, it is ultimately priced by the government). Still, there is often no shortage of jobs as the government functions similarly to a market economy in that it wants to grow and grow upon its populace.
Hand In The Cookie Jar: Interestingly – or maybe, predictably – the government in a command economy only desires to control its most valuable resources. Other things, like agriculture, are left to be regulated and run by the people. This is the nature of a command economy and many communist governments fall into this category.
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3. Market Economic System
A market economy is very similar to a free market. The government does not control vital resources, valuable goods or any other major segment of the economy. In this way, organizations run by the people determine how the economy runs, how supply is generated, what demands are necessary, etc.
Capitalism And Socialism: No truly free market economy exists in the world. For example, while America is a capitalist nation, our government still regulates (or attempts to regulate) fair trade, government programs, moral business, monopolies, etc. etc. The advantage to capitalism is you can have an explosive economy that is very well controlled and relatively safe. This would be contrasted to socialism, in which the government (like a command economy) controls and owns the most profitable and vital industries but allows the rest of the market to operate freely; that is, price is allowed to fluctuate freely based on supply and demand. If you want to know how the global economy works and the role you play in it, check out this sweet class on Economics Without Boundaries.
Market Economy And Politics: Arguably the biggest advantage to a market economy (at least, outside of economic benefits) is the separation of the market and the government. This prevents the government from becoming too powerful, too controlling and too similar to the governments of the world that oppress their people while living lavishly on controlled resources. In the same way that separation of church and state has been to vital to America’s social success, so has a separation of market and state been vital to our economic success. Yes, there is something wary about a system which to be successful must foster constant growth, but as a result progress and innovation have occurred at such incredible rates as to affect the way the world economy functions.
4. Mixed Economic System
A mixed economic system (also known as a Dual Economy) is just like it sounds (a combination of economic systems), but it primarily refers to a mixture of a market and command economy (for obvious reasons, a traditional economy does not typically mix well). As you can imagine, many variations exist, with some mixed economies being primarily free markets and others being strongly controlled by the government. Learn more about an essential part of our economy with this free post on understanding the stock market.
Benefits Of A Mixed Economy: In the most common types of mixed economies, the market is more or less free of government ownership except for a few key areas. These areas are usually not the resources that a command economy controls. Instead, as in America, they are the government programs such as education, transportation, USPS, etc. While all of these industries also exist in the private sector in America, this is not always the case for a mixed economy.
Disadvantages Of A Mixed Economy: While a mixed economy can lead to incredible results (America being the obvious example), it can also suffer from similar downfalls found in other economies. For example, the last hundred years in America has seen a rise in government power. Not just in imposing laws and regulations, but in actually gaining control, becoming more difficult to access while simultaneously becoming less flexible. This is a common tendency of mixed economies.
Please Respect The Thin Line: A current, pivotal debate between Democrats and Republicans is the amount of governmental control. Can a true balance exist? Where should there be more government regulation? Where should there be less? These questions have no real answer; it is subjective, and therefore only a relatively small portion of the population will, at any given time, agree with the state of a mixed economy. It must be a strong form of government indeed to avoid collapsing under this constant pressure.
The American Economy
Now that you have a general idea of how the world’s economies function, you can see how some countries are light-years behind others. But the progress of first-world nations allows slower economies to make faster, longer strides. In fact, there is even reason to hope: several initiatives have been implemented in the past ten years that are helping developing countries avoid making the same mistakes we made: pollution, depletion of resources, civil rights, etc. Learn more about your own government and economy with this top-rated course on how the economy really works in the 21st century.Filed Under: Business, Students
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