11.1 National Differences in Economic Systems

What Is an Economic System?

An economic system is the means by which countries or governments allocate available resources and trade goods and services throughout a specific geographic area.

Resources are allocated to three areas: production, distribution, and consumption.

In the study of economics, resources include any or all of the following:

• land
• natural resources
• labour, physical and mental
• capital (monetary resources, buildings, equipment)
• entrepreneurship and knowledge

The land and natural resources serve as raw materials, which are then transformed into goods and services with the help of labour. The capital (monetary resources, buildings, and equipment) is needed for the production process. Entrepreneurship contributes the skill needed to tie all other resources together to produce goods or services, which are then sold to the marketplace.

Today’s major world economic systems fall into two broad categories: a free market economy (or capitalist) and a command economy (such as socialism). Planned economy is another term for command economy. The differentiator between these two systems is whether the government or an individual decide on the following:

• Control of the factors of production (resources) – by whom and how the factors of production are owned and controlled
• Allocation of resources – the factors of production – how to allocate limited resources to individuals and organizations to best satisfy their unlimited societal needs and wants
• Production of goods and services – what goods and services to produce and in what quantities
• Distribution of the goods and services – how to distribute goods and services to consumers and at what price

Market Economy

In a pure market economy, factors of production (resources) are privately owned. Production of goods and services is not planned by anyone, and it is determined by the interaction of the two forces of a market: supply and demand.

The purchasing pattern of consumers signals to producers what to produce and how much, and the prices of products are also determined through the interaction of supply and demand. If supply exceeds demand, prices will rise and vice versa.

The supply of goods and services must not be restricted for a market to work effectively. Restriction occurs when there is a monopoly in the market. The firm that has the monopoly will reduce the supply of goods in order for the prices to go up so that the firm can make more profit. When a firm has a monopoly, the motivation for efficiency and quality of the product can also go down because the firm can transfer the cost to the consumer. This is not good for the welfare of the society.

The role of the government in a market economy is to encourage fair and free competition. Governments introduce laws and regulations such as antitrust laws in the United States and European Union.

Command Economy

In a pure command economy, the production of goods and services is planned by the state. The government decides what to produce, how much to produce and at what price. In addition, in a pure command economy, all businesses are owned by the state. Thus, the government has the ability to direct resources where they are most needed and where those resources can serve the interest of the nation better as a whole rather than individuals.

In today’s world, we can find a mix of both market and command economies. All countries have certain sectors of the economy where there is state ownership, and the remaining sectors are left to the private ownership and free market mechanism. They are called mixed economies.

For example, in Canada, there are some state-owned corporations called Crown Corporations, and they control certain sectors of the economy, such as VIA Rail Canada Inc., Canada Post Corporation, Atomic Energy of Canada Ltd., Bank of Canada, etc.

Companies that do business internationally must understand and adapt to the economic systems of the countries in which they operate and adjust their production and selling methods to accommodate the economic system of those countries.

References

Wikipedia contributors. (2024, June 11). Monopoly. Wikipedia. https://en.wikipedia.org/wiki/Monopoly

Attributions

“11.1 National Differences in Economic Systems” is adapted from “1.2 Economic Systems Around the World” from Introduction to Management by Kathleen Rodenburg, licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.