For businesses, the economic system is important. Business success depends on the economic system in which they present and where they sell their products. In extreme cases, private businesses cannot operate in the command economic system. Conversely, in a free-market economic system, they can compete freely for profit.
Multinational companies often face challenges when they are in different economic systems. They often have to make changes in production and sales methods to accommodate economic systems in other countries.
Definition of the economic system
The economic system is a system that defines how economic resources are allocated among a country’s population. It becomes a means by which economic actors distribute resources and trade goods and services. It was used to control four production factors, including labor, capital, entrepreneurs, and land.
The system aims to solve basic economic problems and answer three economic questions, namely:
- What goods and services are produced
- How to produce? and how much
- For whom provide products and services
The system involves three main actors, namely individuals, businesses, and government. The role of each actor depends on what system is adopted by a country. In some countries, the government plays a very dominant role. While in other countries, the private sector (individuals and businesses) plays a more critical role.
Types and characteristics of each economic system
There are four types of economic systems:
Traditional economy is almost impossible to find in modern economies, except in inland tribes. Most countries adopt a mixed economy, a combination of a free-market economy and a command economy.
This system works based on customs and traditions. Community agreement is a determinant of decisions about what, how, and for whom to produce. In this system, property ownership is not well defined. Law enforcement related to ownership is also not yet developed.
Traditional economy is almost impossible to find today. You might still be able to find it in the tribal interior.
The most striking weakness of this system is that economic activity develops very slowly. However, this system also contributes to the preservation of nature. Their activities are more environmentally friendly because they depend on nature for their livelihoods.
Free market economy
A free-market economy puts forward the market mechanism for allocating resources. The basic idea of a free market economy is that producers and consumers are free to decide how to utilize resources. They are economic actors involved in the production, distribution, and consumption of goods and services.
Market mechanisms work through the forces of demand and supply. When demand for an item rises, prices will increase and encourage producers to divert resources to produce it. Conversely, when demand falls, prices fall, and some businesses move to the production of other goods.
The private sector (individuals and businesses) have the right to own property. Simultaneously, the role of government is very limited and only plays a role in protecting ownership. The government does not interfere with the work of the market.
The profit motive is the next feature of this system. It encourages companies to compete and innovate to meet the needs and desires of consumers most efficiently.
This system allows efficient allocation of resources. The free market responds quickly to people’s desires. Competition and innovation lead to the availability of goods, services in large numbers, diverse and cheaper.
However, because the main motive is profit, certain goods or services (such as public goods) are rare. Businesses don’t want to provide it because it’s unprofitable.
Unemployment is a common phenomenon in this system. Businesses will use the most efficient factors of production, including replacing labor with machinery.
Competition, both individuals and businesses, leads to one winner. Those who win will rule the economy, and because the government did not intervene, it raises problems such as the income gap and anti-competitive behavior (like cartels).
The command economy is the opposite of a free-market economy. The government decides to allocate resources, including what is produced, how to produce and distribute goods and services. The state also determines how the distribution of income and wealth is allocated among the people.
This system does not allow private businesses to operate. Likewise, the market mechanism also does not work.
The social welfare motive replaces the profit motive. Individuals do not compete with each other, but rather do what the government plans. That’s because of government control and planning control economic activities.
This system enables more equitable welfare. Also, unemployment is low because the government can require everyone to work on government projects.
The command economy tends to be much more stable than the market economy. Prices remain manageable. Thus, everyone can consume goods and services.
However, this system often raises political corruption, where government officials often act in their interests. That often causes the failure of this system in various countries such as the Soviet Union.
Another weakness is that people are not motivated to work and innovate. The low competition also contributes to the poor quality of goods and inefficient production. Because market mechanisms do not work, scarcity is a common phenomenon.
A mixed economy combines a market system and a command system. This system tries to overcome the weaknesses in the two systems. Most countries adopt this system but with different portions. For example, China is more inclined to the command economy, while the United States is a more free market.
This system combines the private sector and the public sector roles in answering the three basic questions above. Both have a role in allocating resources. The public sector usually supplies public goods, such as infrastructure and health services. And, the private sector plays a role in other parts of the economy. There is also a combined sector, namely the Public-Private Partnership.
In addition to providing public goods, the government also plays a role in making regulations and policies. To ensure fair competition, for example, the government launched an antitrust law. To maintain economic stability, the government also adopts policies such as monetary and fiscal policies.
Although trying to overcome problems in the free market and command economy systems, other issues often arise. Governments often make policies that benefit certain economic actors. Bailouts, for example, tend to protect big businesses rather than small businesses.
In your opinion, which is the ideal economic system?
There is no perfect economic system. But, if I have to choose, a mixed economic system is ideal. At least, the reason is that most countries have adopted it.
Theoretically, that is so. But, what percentage of the mixture to produce a perfect system, it has not been answered.
And, in practice, it’s not as simple as theory. That is why, although most countries adopt it, problems often arise.
What to read next
- Scarcity in Economics: Meaning and Explanation
- Economic Resources: Definition, Types
- Needs: Definition, Example, Type
- Wants: Definition and Examples
- Choices in economic: Meaning, Importance, Reasons
- Opportunity Cost: Meaning, Importance, Examples
- Economic System: Types and Characteristics
- Three Basic Economic Questions and Resource Allocation