3.2: Economic Systems
Economists study the interactions between households and businesses and look at the ways in which the factors of production are combined to produce the goods and services that people need. Basically, economists try to answer three sets of questions:
- What goods and services should be produced to meet consumers’ needs? In what quantity? When?
- How should goods and services be produced? Who should produce them, and what resources, including technology, should be combined to produce them?
- Who should receive the goods and services produced? How should they be allocated among consumers?
The answers to these questions depend on a country’s economic system — the means by which a society (households, businesses, and government) makes decisions about allocating resources to produce products and about distributing those products. The degree to which individuals and business owners, as opposed to the government, enjoy freedom in making these decisions varies according to the type of economic system.
Generally speaking, economic systems can be divided into two systems: planned systems and free market systems (refer to Figure 3.3).
Planned Systems
In a planned system, the government exerts control over the allocation and distribution of all or some goods and services. The system with the highest level of government control is communism. In theory, a communist economy is one in which the government owns all or most enterprises. Central planning by the government dictates which goods or services are produced, how they are produced, and who will receive them. In practice, pure communism is practically nonexistent today, and only a few countries (notably North Korea and Cuba) operate under rigid, centrally planned economic systems.
Under socialism, industries that provide essential services, such as utilities, banking, and health care, may be government-owned. Some businesses may also be owned privately. Central planning allocates the goods and services produced by government-run industries and tries to ensure that the resulting wealth is distributed equally. In contrast, privately owned companies are operated for the purpose of making a profit for their owners. In general, workers in socialist economies work fewer hours, have longer vacations, and receive more health care, education, and child-care benefits than do workers in capitalist economies. To offset the high cost of public services, taxes are generally steep. Examples of countries that lean toward a socialistic approach include Venezuela, Sweden, and France.
Free Market System
The free market system is an economic system in which most businesses are owned and operated by individuals, also known as capitalism. In a free market economy, competition dictates how goods and services will be allocated. Business is conducted with more limited government involvement, concentrated on regulations that dictate how businesses are permitted to operate. A key aspect of a free market system is the concept of private property rights, which means that business owners can expect to own their land, buildings, machines, etc., and keep the majority of their profits, except for taxes. The profit incentive is a key driver of any free market system. The economies of the United States and other countries, such as Japan, are based on capitalism. However, a purely capitalistic economy is as rare as one that is purely communist. Imagine if a service such as police protection, one provided by the government in the United States, were instead allocated based on market forces. The ability to pay would then become a key determinant of who received these services, an outcome that few in American society would consider acceptable.
Mixed Market Economies
Though it is possible to have a pure communist system, or a pure capitalist (free market) system, in reality many economic systems are mixed market economies. A mixed market economy relies on both markets and the government to allocate resources. In practice, most economies are mixed, leaning toward either free market or socialist principles rather than being purely one or the other. Some previously communist economies, such as those of Eastern Europe and China, are becoming more mixed as they adopt more capitalistic characteristics and convert businesses previously owned by the government to private ownership through a process called privatization. By contrast, Venezuela is a country that has moved increasingly toward socialism, taking control of industries such as oil and media through a process called nationalization.
The Canadian Economic System
Like most countries, Canada features a mixed market system much like its neighbour to the south; though the Canadian and U.S. economic systems are primarily free market systems, the federal government controls some basic services, such as the postal service and air traffic control. The Canadian economy also has some characteristics of a socialist system, such as providing social security retirement benefits to retired workers or free health care to its population.
Adam Smith espoused the free market system in his book The Wealth of Nations, published in 1776. According to Smith, competition alone would ensure that consumers received the best products at the best prices. In the kind of competition he assumed, a seller who tries to charge more for his product than other sellers would not be able to find any buyers. A job-seeker who asks more than the going wage won’t be hired. Because the “invisible hand” of competition will make the market work effectively, there won’t be a need to regulate prices or wages. Almost immediately, however, a tension developed among free market theorists between the principle of laissez-faire—leaving things alone — and government intervention. Today, it is common for the Canadian government to intervene in the operation of the economic system. For example, the government exerts influence on the food and pharmaceutical industries through Canada’s Food and Drug Act and Regulations, which protect consumers by preventing unsafe or mislabeled products from reaching the market.
To appreciate how businesses operate, we must first get an idea of how prices are set in competitive markets. The next section, “Perfect Competition and Supply and Demand,” begins by describing how markets establish prices in an environment of perfect competition.
Indigenous Entrepreneurship and Economic Leakage
Economic development through resource extraction is an important tool for the creation of own-sourced revenue. To achieve long-term economic sustainability, however, it must be supported by community-appropriate business development. Various Indigenous communities authorize impact and benefit agreements with multi-national resource extraction corporations, doing so with the intention that the economic benefits will offset the resulting ethical and environmental concessions. In reality, the agreements often leave the communities in a similar socio-economic state before the resources were extracted, which is attributed to the phenomenon of economic leakage. Business development for Indigenous populations, on the other hand, refers to the strategic decision to produce and promote businesses for and within their own communities. Doing so would not only recapture economic leakage but also provide additional revenue sources. Dr Russell Evans, the professor of accounting at the University of Windsor, offers his insight into the benefits of Indigenous entrepreneurship.
Watch the Indigenous Lifeways in Canadian Business video “Indigenous Entrepreneurship.”
Transcript of “Indigenous Entrepreneurship” video [PDF–New Tab]. Closed caption available in video player.
Source: “Indigenous Entrepreneurship” by University of Windsor, is licensed under CC BY-NC-ND 4.0, available in Indigenous Lifeways in Canadian Business by Russell Evans, Michael Mihalicz, and Maureen Sterling, licensed under a CC BY-NC 4.0 license, except where otherwise noted.
Media Attributions
“Figure 3.3: Economic Systems: Planned, free, and mixed” is reused from The economic spectrum, © 2022 by Kindred Grey, licensed CC BY 4.0.
Image Descriptions
Figure 3.3
The economic spectrum is represented as an outlined horizontal, double-headed arrow. The left side is labelled “Pure Communism” in blue, with North Korea beneath it, and the right side is labelled “Pure Free Market Capitalism in orange, with New Zealand beneath it. Inside the central section of the arrow is a heading in bold labelled “Mixed Economies” with a greyed out heading on the left with the label “Socialism,” and a greyed out heading on the right labelled “Libertarianism”. Directly under the heading Mixed Economies is a smaller greyed out heading labelled “Centralism”. Lines with arrows point downward from markers along the spectrum to list example countries: “China” and “Morocco” fall under “Socialism,” while “France” and “Sweden” are aligned with “Centralism.” “United States” and “Japan” are positioned under “Libertarianism.”
An economic system in which the elements of an economy (such as labour, capital, and natural resources) are subject to government control and regulation designed to achieve the objectives of a comprehensive plan of economic development.
A political and economic system that aims to eliminate class distinction by sharing wealth equally and having the public own the means of production, such as factories and mines.
An economic and political system where the means of production are owned by the public or the state, rather than private individuals. It's based on the idea that shared ownership of resources leads to a more equitable society.
An economic system that operates according to free competition.
An economic system that promotes the creation and ownership of capital and wealth.
An economic system blending elements of a market economy with elements of a planned economy, markets with state interventionism, or private enterprise with public enterprise.
