Economic System
When companies want to do business in other countries, they need to
adjust their business plans to meet local customs. This is what McDonald’s
corporation had to do when it expanded to India. While India’s economy
shares many characteristics with the United States, many of its business
practices are based on a more traditional economic system.
All societies use an economic system—an organized way of providing
for the wants and needs of their people. The way societies organize
themselves determines the type of economic system they have. Three major
kinds of economic systems exist—traditional, command, and market
economies. In practice, however, almost all economies, like that of India,
combine elements of all three.
Traditional Economies
Many of our actions spring from habit and custom. Why, for example,
does the bride toss the bouquet at a wedding? Such practices have become
part of our traditional culture.
Characterictics
In a society with a traditional economy, the use of scarce resources—
and nearly all other economic activity—stems from ritual, habit, or custom.
Habit and custom also dictate most social behavior. Individuals are
generally not free to make decisions based on what they want or would like
to have. Instead, their roles are defined by the customs of their elders and
ancestors.
Examples
Many societies—such as the central African Mbuti, the Australian
Aborigines, and other indigenous peoples around the world—have
traditional economies. The Inuit of northern Canada in the 1800s provide an
especially interesting case of a traditional economy. For generations, Inuit
parents taught their children how to survive in a harsh climate, make tools,
fish, and hunt. Their children, in turn, taught these skills to the next
generation. When the Inuit hunted, it was traditional to share the spoils of
the hunt with other families. If a walrus or bear was taken, hunters divided
the kill evenly into as many portions as there were heads of families in the
hunting party. The hunter most responsible for the kill had first choice, the
second hunter to help with the kill chose next, and so on. Because the Inuit
shared freely and generously with one another, members of the hunting
party later shared their portions with other families who had not
participated.
The result was that the hunter had the honor of the kill and the respect
of the village, rather than a physical claim to the entire animal. Because of
this tradition of sharing, a village could survive the long, harsh winters as
long as skilled hunters lived in the community. This custom was partially
responsible for the Inuit’s survival for thousands of years.
Adventages
The main advantage of a traditional economy is that everyone knows
which role to play. Little uncertainty exists overWHAT to produce. If you are
born into a family of hunters, you hunt. If you are born into a family of
farmers, you farm. Likewise, little uncertainty exists over HOW to produce,
because you do things much the same way your parents did. Finally, the FOR
WHOM question is determined by the customs and traditions of the society.
In some societies, you would provide for your immediate family. In others,
such as the Inuit, you would share what you have hunted with all families of
the village. In other words, tradition dictates how people live their lives.
Disadventages
The main drawback of a traditional economy is that it tends to
discourage new ideas and new ways of doing things. The strict roles in a
traditional society have the effect of punishing people who act differently or
break the rules. The lack of progress leads to economic stagnation and a
lower standard of living than in other economic systems.
Command Economies
In a command economy, a central authority makes the major decisions
about WHAT, HOW, and FOR WHOM to produce. A command economy can
be headed by a king, a dictator, a president, or anyone else who makes the
major economic decisions.
Characteristics
In a pure command economy, the government makes the major
economic decisions. This means that the government decides if houses or
apartments will be built. It also decides on the best way to build them, as
well as who will receive them. Most command economies severely limit
private property rights. People are not allowed to own their homes,
businesses, andother productive resources, although they may have some
personal items and tools. Individual freedom also is limited. For example, if
the government wants engineers rather than social workers, then its
universities will train more engineers. This limits individual choices because
people have to live within the government’s restrictions. Finally, government
officials tend to favor themselves when making economic decisions. The
result is that some of the country’s money often goes to luxury goods like
houses, cars, and extravagant vacations for these officials.
Examples
Because they tend to be unproductive, few pure command economies
exist today. North Korea and Cuba are modern examples, but in the 1970s
and 1980s, the communist bloc countries of the former Soviet Union had
command economies. In the former Soviet Union, for example, the State
Planning Commission determined needs, set goals, and established
production quotas for major industries. If it wanted growth in heavy
manufacturing, it would allocate resources to that sector. If it wanted to
strengthen national defense, it directed resources to military production.
Adventages
The main strength of a command system is that it can change direction
drastically. The former Soviet Union went from a rural agricultural society to
an industrial nation in a few decades by emphasizing the growth of heavy
industry. During this period, the central planning agency shifted resources
on a massive scale.
Another advantage of command economies, especially those
represented by the former Soviet Union, is that many health and public
services are available to everyone at little or no cost.
Disadventage
Pure command economies have their disadvantages. One is that they
ignore the basic wants and needs of consumers. In the Soviet Union, for
example, generations of people were forced to do without consumer goods
and adequate housing. Similarly, the current North Korean government has
put a strong emphasis on defense. In the meantime, the North Korean
people have been suffering years of hunger. At times, the government even
had to accept aid from international sources. A second disadvantage is that
the system gives people the incentive to fill their quotas instead of producing
a good product. At one time in the former Soviet Union, quotas for electrical
motors were measured in tons of output. Soviet workers then filled their
quotas by producing the world’s heaviest electrical motors.
A third weakness is that a command economy requires a large decision-
making bureaucracy. In the former Soviet Union, an army of clerks, planners,
and other administrators was needed to operate the system. This structure
slowed decision making and raised the cost of production. Yet a fourth
weakness is that the planning bureaucracy lacks the flexibility to deal with
minor day-to-day problems. As a result, command economies tend to lurch
from one crisis to the next—or collapse completely, as did the former Soviet
Union. Finally, rewards for individual initiative are rare in a command
economy. Each person is expected to perform a job in a factory or on a farm
according to the decisions made by central planners.
Market Economies
In a market economy, people make decisions in their own best interest.
In economic terms, a market is an arrangement that allows buyers and
sellers to come together to exchange goods and services. A market might be
in a physical location, such as a farmers’ market, or on an Internet site, such
as eBay. Regardless of its form, a market can exist as long as a mechanism
is in place for buyers and sellers to meet.
Characteristics
A market economy is characterized by a great deal of freedom. People
can spend their money on the products they want most, which is like casting
dollar “votes” for those products. This tells producers which products
people want, thus helping them answer the question of WHAT toproduce.
Businesses are free to find the best production methods when deciding
HOW to produce. Finally, the income that consumers earn and spend in the
market determines FOR WHOM to produce. Market economies also feature
the private ownership of resources. A market economy is often described as
being based on capitalism—an economic system where private citizens own
the factors of production. The term capitalism draws attention to the private
ownership of resources, while the term market economy focuses on where
the goods and services are exchanged. As a result, the two terms focus on
different features of the same economy.
Examples
Many of the most prosperous economies in the world, such as the
United States, Japan, South Korea, Singapore, Australia, Great Britain, and
parts of Western Europe, are based on markets and capitalism. While there
are significant differences among them, these economies share the
common elements of markets and the private ownership of resources to
seek profits.
Advantages
The first advantage of a market economy is its high degree of individual
freedom. People are free to spend their money on almost any good or service
they choose. They also are free to decide where and when they want to work,
or if they want to invest further in their own education and training. At the
same time, producers are free to decide whom they want to hire, which
inputs they want to use, as well as the way they want to produce.
The second advantage of a market economy is that it adjusts gradually
to change over time. Prior to 2005, for example, gasoline prices were low, so
people tended to buy large gas-guzzling SUVs. When the price of gas rose
sharply in that year, SUV sales fell, and smaller, more fuel-efficient vehicles
became popular. A third advantage is the relatively small degree of
government interference. Except for certain concerns such as national
defense, environmental protection, and some care for the elderly, the
government normally tries to stay out of the way of buyers and sellers.
A fourth advantage is that decision making is decentralized. Billions, if
not trillions, of individual economic decisions are made daily. Collectively,
people make the decisions that direct scarce resources into the uses
consumers favor most, so everyone has a voice in the way the economy
runs. A fifth advantage of the market economy is the variety of goods and
services. You can find ultrasound devices to keep the neighbor’s dog out of
your yard, or you can download music and video to your cell phone. In short,
if a product can be imagined, it is likely to be produced in hopes that people
will buy it. A sixth advantage is the high degree of consumer satisfaction. In
a market economy, the choice one group makes does not affect the choices
of other groups. If 51 percent of the people want to buy classical music, and
49 percent want to buy rap music, people in both groups can still get what
they want.
Disadvantage
The market economy does not provide for everyone. Some people may
be too young, too old, or too sick to earn a living or to care for themselves.
These people would have difficulty surviving in a pure market economy
without assistance from family, government, or charitable groups. A market
economy also may not provide enough of some basic goods and services.
For example, private markets do not adequately supply all of the roads,
universal education, or comprehensive health care people would like to
have. This is because private producers concentrate on providing products
they can sell for a profit. Finally, a market economy has a high degree of
uncertainty. Workers might worry that their company will move to another
country in search of lower labor costs. Employers may worry that someone
else will produce a better or less expensive product, thereby taking their
customers.
Mixed Economies
While textbooks identify neat categories like traditional, command, and
market economies, the real world is not so orderly. Most countries have
mixed economies— systems that combine elements of all three types.
When we consider political systems as well as economic systems, the
picture gets even more complicated. For example, socialism is a mixed
economic and political system in which the government owns and controls
some, but not all, of the basic productive resources. In socialistic countries,
the government also provides some of the basic needs of its people, such as
education and health care.
An extreme form of socialism is communism—a political and economic
system where all property is collectively—not privately—owned. In a
communist system, labor is organized for the common advantage of the
community, and everyone consumes according to their needs. In practice,
however, communist governments have become so involved in economic
decisions that they are often called command economies.
Charactistics
If government or tradition, as well as markets, answer some of the
questions of WHAT, HOW, and FOR WHOM to produce, then a society has a
mixed economy. The type of political system in a mixed economy is less
important than the way basic economic decisions are made. For example,
some mixed economies have a political system based on democracy, and
others do not. The state’s involvement in economic decisions also can vary.
Some governments provide only for basic needs such as defense, a justice
system, anduniversal education. The more socialistic a country is, the more
it will make major economic decisions, often with the claim that this is done
for the betterment of the people. Some governments intervene only in
certain key sectors or industries and leave the rest to markets. If the
government intervenes too much, a mixed economy can turn into a
command economy.
Examples
There is a wide range of mixed economies. China has a mixture of
traditional, command, and market economies. While tradition has a strong
influence in rural areas, the government makes many of the major economic
decisions and owns many of the factors of production. China is changing,
however. In recent years the government has allowed some private
ownership of resources, and capitalism is beginning to flourish. In Norway,
the government owns the basic petroleum industry. It uses the revenue from
the sale of oil to other nations to keep its domestic gas prices low, finance
education, maintain roads, and provide social welfare for its citizens.
Because the government controls just one industry, the mixed economy is
based on capitalism and markets with some elements of socialism. Cuba
and North Korea today are very similar to the former Soviet Union, where a
socialist government controlled resources to provide for all the people.
However, the ownership and control of resources were so extensive that
many economists thought of the country as a command economy.
Adventages
One advantage of a mixed economy is that it provides assistance for
some people who might otherwise be left out. All societiesinclude some
people who are too young, too old, or too sick to provide for themselves, for
example, and most societies have traditions that address some of these
concerns. If the society has a democracy, voters can use their electoral
power to affect the WHAT, HOW, and FOR WHOM decisions even if the
government owns no productive resources. For example, the government
can pass laws to provide aid for those most in need or to fund road
construction. Under socialism, the FOR WHOM question is addressed more
directly. Ideally, those who are not fortunate or productive enough to take
care of themselves still share certain benefits, such as free or low-cost
public housing, transportation, medical care, and education.
Disadventages
While mixed economies tend to provide more services, the costs for
these benefits can mean higher costs for citizens overall. Germany, for
example, offers a wide range of benefits, but it also has a high tax rate. During
economic downturns, when the government collects fewer taxes, less
money is available for these programs. The German government has
discussed placing limits on benefits, such as unemployment and welfare,
because of lower revenues. In some socialist countries, the availability of
services may be limited or the quality may deteriorate over time. Today, for
example, Cuba claims that it has free health care for everyone, but the care
is substandard for everyone except high-ranking members of the
Communist Party and those willing to pay for services in dollars. Historically,
both socialism and communism have proved to be less efficient than
capitalism. For example, if workers receive government guarantees of jobs,
more workers may be hired in a plant than are necessary, driving up
production costs. Because socialism has proved to be so inefficient, many
socialistic countries today allow more capitalist development. This is
especially true in China, where the emergence of capitalism has helped the
country to become one of the major economic powers in the world today.
