The 3 different types of economies:

  • Traditional Economies
  • Market Economies
  • Command Economies

Traditional economy is an original economic system in which traditions, customs, and beliefs help shape the goods and the services the economy produces, as well as the rules and manner of their distribution. Countries that use this type of economic system are often rural and farm-based.

Characteristics of a Traditional Economy

Traditional economies are often based on one or a few of agriculture, hunting, fishing, and gathering. Traditional economies are still found in many developing countries- in parts of Africa, Asia, South America, and the Middle East, parts of northern Canada.

The activity in a market economy is unplanned; the decisions are made in markets, where individuals or enterprises voluntarily agree to exchange goods and services, usually through payments of money. There is no central authority that takes or implements decision in this kind of an economy. Alternatively, a command economy is one in which all the important decisions about production and distribution are taken by the government. The government owns the factors of production and also directs the operations of the enterprises.

Market Economy

Command Economy

Based on the Ownership and Control over Means of Production or Resources the economies are divided into three types:

Resources or means of production remain either in private ownership with full individual freedom to use them for the profit motive or they can be in collective ownership (government control) and can be used for the collective welfare of the society as a whole. Based on the criterion of degree of individual freedom and profit motive, economies are labelled as:

  • Capitalist or free enterprise economy
  • Socialist or centrally planned economy
  • Mixed economy

Capitalist Economy:

The capitalist or free enterprise economy is the oldest form of economy. Earlier economists supported the policy of ‘laissez fair’ meaning ‘leave free’. They advocated minimum government intervention in the economic activities. The following are the main features of a capitalist economy;

  • Private property:In a capitalism system all the individuals have the right to own property. An individual can acquire property and use it for the benefit of his own family. There is no restriction on the ownership of land, machines, mines, factories and to earn profit and accumulate wealth. After the death of a person the property or wealth is transferred to the legal heirs. Thus the institution of private property is sustained over time by the right of inheritance.
  • Freedom of enterprise:In a capitalist economy the government does not coordinate production decisions of the citizens. Individuals are free to choose any occupation. Freedom of enterprise implies that business firms are free to acquire resources and use them in the production of any good or service. A worker is free to choose his/her employer. In small business units owner himself takes the risk of production and earns profit or loss for himself.
  • Consumer’s Sovereignty:In a capitalist economy consumers are like a king. They have the full freedom to spend their income on goods and services that give them maximum satisfaction.
  • Profit Motive:Self-interest is the guiding principle in capitalism. Therefore entrepreneurs are always motivated to maximize their residual profit by minimizing cost and maximizing revenue.
  • Competition:There are no restrictions on the entry and exit of firms in a capitalism system. Competition is the fundamental feature of capitalist economy and essential to safeguard against consumer’s exploitation.
  • Importance of markets and prices:Capitalism is essentially a market economy where every commodity has a price. The forces of demand and supply in an industry determine this price. Firms which are able to adjust at a given price earn normal profit and those who fail to do so often quit the industry.
  • Absence of government interference:In a free enterprise or capitalist economy the price system plays an important role of coordinating agent. Government intervention and support is not required. The role of government is to help in free and efficient functioning of the markets.

Disadvantages of Capitalism:

  • Monopoly power:Private ownership of capital enables firms to gain monopoly power in product and labour markets. Firms with monopoly power can exploit their position to charge higher prices.
  • Social benefit ignored:A free market will ignore externalities. A profit maximising capitalist firm is likely to ignore negative externalities, such as pollution from production; this can harm living standards. Similarly, a free market economy will under-provide goods with positive externalities, such as health, public transport and education. This leads to an inefficient allocation of resources.
  • Inherited wealth and wealth inequality:A capitalist society is based on the legal right to private property and the ability to pass on wealth to future generations. Capitalists argue that a capitalist society is fair because you gain the rewards of your hard work. But, often people are rich, simply because they inherit wealth or are born into a privileged class. Therefore, capitalist society not only fails to create equality of outcome but also fails to provide equality of opportunity.
  • Inequality creates social division:Societies which are highly unequal create resentment and social division.
  • Diminishing marginal utility of wealth:A capitalist society argues it is good if people can earn more leading to income and wealth inequality. However, this ignores the diminishing marginal utility of wealth. A millionaire who gets an extra million sees little increase in economic welfare, but that £1 million spent on health care would provide a much bigger increase in social welfare.
  • Boom and bust cycles:Capitalist economies have a tendency to booms and busts with painful recessions and mass unemployment.

Capitalism in today’s world: Pure capitalism is not seen in the world now-a-days. The economies of USA, UK, France, Netherland, Spain, Portugal, Australia etc. are known as capitalistic countries with active role of their respective government in economic development.

Socialist EconomyIn the socialist or centrally planned economies all the productive resources are owned and controlled by the government in the overall interest of the society. A central planning authority takes the decisions. The socialist economy has the following main features:

  • Collective Ownership of means of Production:In a Socialist economy means of production are owned by the government on behalf of the people. The institution of private property is abolished and no individual is allowed to own any production unit and accumulate wealth and transfer it to their heirs. However, people may own some durable consumer goods for their personal use.
  • Social Welfare Objective:The decisions are taken by the government at macro level with the objective of maximization of social welfare in mind rather than maximization of individual profit. The forces of demand and supply do not play any important role.
  • Central Planning:Economic planning is an essential feature of a socialist economy. The Central Planning Authority keeping the national priorities and availability of resources in mind allocates resources. The planning authorities fix targets for various sectors and ensure efficient utilization of resources.
  • Reduction in Inequalities:The institutions of private property and inheritance are at the root of inequalities of income and wealth in a capitalist economy. By abolishing these twin institutions a socialist economic system is able to reduce the inequalities of incomes. It is important to note that perfect equality in income and wealth is neither desirable nor practicable.
  • No class conflict:In capitalist economy the interests of the workers and management are different. Both of them want to maximize their own individual profit or earnings. This results in class conflict in capitalist economy. In socialism there is no competition among classes. Every person is a worker so there is no class conflict. All are co-workers.

Disadvantages of Socialism

  • Elimination of Individualism:In socialist economic system everything is controlled by a centralized body. Individuals are not allowed to own any assets, everything belongs to the state. Workers are assigned specific jobs and are not allowed to change them without consent from the planning authority.
  • Red-Tapism and Inefficiency:In socialism there is a lot of involvement of bureaucracy and are the drivers of all economic machinery. The work of civil servants are not comparable with the private entrepreneurs. Civil servants merely do the jobs because it is their duty and they will get paid whatever the consequences. Thus inefficiency arises and in the long run the economy suffers.
  • An Artificial System:As a socialist economy is a planned economy, every aspect of the economy is to be determined by the government. Forces of demand and supply do not apply which is one of the disadvantages of socialism.
  • Consumers Suffer:Sovereignty of consumer does not apply in a socialist economy. Consumers do not enjoy the status of a consumer as in a capitalist economy. Choices of goods and services are not able to maximize their total satisfaction.
  • Economic Equality:Socialists claim more equal distribution of wealth but practically it is proven that complete economic equality is virtually impossible. There is a distinction between the rich and poor. Moreover since it is a planned economy the poor suffer even more.
  • Loss of Liberty:One of the main dangers of socialism is that it not only curtails individual liberty but also take away freedom completely. Under socialism there is no scope for consumers sovereignty; the workers will have no choice of occupation, and labour, just like any other economic resource, will be under planned management. The consumers should take what is given and workers should work in such places as the authorities will decide. Of course, there will be no unemployment, but this is hardly an advantage because the terms of employment (hours, wages etc.,) will be fixed by the central authorities. Security of employment is no compensation for loss of liberty. There is no unemployment even in prison.
  • Non-existence of Competition:It is due to competition that an economy becomes prosperous. The competition between producers and consumers leads to the production of a good quality product which may even be relatively cheap here it is one the disadvantages of socialism. Thus talents and initiatives of mankind develop and in the ultimate analysis the country incurs rapid growth.

Socialism in today’s world: Countries such as Russia, China and many eastern European countries are said to be socialist countries. But they are changing now and encouraging liberalisation in their countries for their economic development.

“If a man is not a socialist by the time he is 20, he has no heart. If he is not a conservative by the time he is 40, he has no brain. ”  – Winston Churchill

Mixed Economy A mixed economy combines the best features of capitalism and socialism. Thus mixed economy has some elements of both free enterprise or capitalist economy as well as a government controlled socialist economy. The public and private sectors co-exist in mixed economies. The main characteristics of a mixed economy are as follows:

  • Co-existence of public and private sectors:The private sector consists of production units that are owned privately and work on the basis of profit motive. The public sector consists of production units owned by the government and works on the basis of social welfare. The areas of economic activities of each sector are generally demarcated.
  • Individual Freedom:Individuals take up economic activities to maximize their personal income. They are free to choose any occupation and consume as per their choice. But producers are not given the freedom to exploit consumers and labourers. Government puts some restrictions keeping in mind the welfare of the people.
  • Economic Planning:The government prepares long-term plans and decides the roles to be played by the private and public sectors in the development of the economy. The public sector is under direct control of the government as such production targets and plans are formulated for them directly. The private sector is provided encouragement, incentives, support and subsidies to work as per national priorities.
  • Price Mechanism:Prices play a significant role in the allocation of resources. For some sectors the policy of administered prices is adopted. Government also provides price subsidies to help the target group. The aim of the government is to maximize the welfare of the masses.

Thus in a mixed economy people at large enjoy individual freedom and government support to protect the interests of weaker sections of the society.
Indian economy is considered a mixed economy as it has well defined areas for functioning of public and private sectors and economic planning. Even countries such as USA, UK, etc. which were known as capitalistic countries are also called mixed economies now because of active role of their government in economic development.

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