Economic Systems: Tradition, Command, and Market

• An economic system addresses what goods and services are produced, how they are produced, and for whom they are produced.

Output Questions

• These concern the types and quantities of goods and services produced.

Input Questions

• These deal with how goods and services are produced, including resource allocation.

Distribution Questions

• Relate to for whom the various goods and services are produced and where production occurs.

Classifying Economic Systems

• Economic systems can be classified based on tradition, command, and market mechanisms.

Tradition

• Tradition involves passing down information, methods, and beliefs from one generation to the next.
• In economic terms, this means goods, tasks, and production methods are passed down.
• The same goods are produced and distributed in the same ways across generations.

Command

• Command involves a central plan by a central authority that dictates what, how, and for whom to produce.

Market

• A market is any interaction between potential buyers and sellers of a good or service, whether local, regional, or national.
• For a market to exist, there must be at least one potential buyer and seller, a good or service available for sale, the means to purchase, a determined exchange ratio (market price), and a guaranteed agreement by law or tradition.

Property Rights

• Property rights are a basic criterion for classifying economic systems, referring to the right to possess, use, or dispose of tangible and intangible assets, and the income generated by them.
• Economic systems are classified by the predominant form of ownership of productive assets, which can be public (socialism) or private (capitalism).

Coordinating Mechanisms

• Coordinating mechanisms classify economic systems.
• They provide and transmit information to coordinate economic activities. The main mechanisms are tradition, command, and market.

Socialism

• Socialism involves public (state) ownership of the factors of production.
• Decision-making can be centralized (planned socialism) or decentralized and coordinated by the market (market socialism).
• Command mechanisms are typically used in socialist systems.

Capitalism

• Capitalism features private ownership of the factors of production.
• Decision-making is decentralized with the owners.
• Market systems are often referred to as capitalist systems, because the market mechanism tends to align with capitalist ownership.

Economic System (Definition)

• An economic system aims to solve the questions of what goods and services are produced (output), how resources are allocated (input), and for whom goods and services are produced (distribution).
• Property rights and coordinating mechanisms (tradition, command, and market) form the basis of the traditional, command, market, and mixed systems.

The Traditional System

• The traditional system produces and distributes goods the same way each generation does.
• clear answers to the three economic questions but is rigid and slow to change.
• Economic activity is often secondary to cultural values and maintaining the status quo.
• Ownership of the factors of production is determined by tradition, and all decisions are made by tradition as well.

The Command System

• In the command system, the central authority instructs participants on what and how to produce, and also how to distribute output.
• Also known as a centrally planned system, it involves state ownership of goods, services, and factors of production (except labor).
• Decision making is centralized and coordinated by a central plan. Property rights involve state ownership of all goods, services, and factors of production (except labor), and all decisions are made by a central authority.

The Market System

• The market system features minimal government intervention/central planning, where economic decisions result from the interactions between buyers and sellers and their effect on supply and demand (indicated by market prices).
• Driven by self-interest, the market mechanism, like an "invisible hand", coordinates individual actions to benefit everyone.
• Characterized by individualism, private freedom, decentralized decision-making, and limited government intervention.
• Private property ownership and rights dominate.
• Important aspects of a market system include incentives and competition.
• Inequality and instability are defects, but adjustments can compensate for these.
• Property rights are characterized by the private ownership of the factors of production.
• Coordination occurs through voluntary exchanges that reflect market prices.

Characteristics of the Market System

• Includes incentives, competition, negotiation, market capitalism, and market prices.
• An incentive is an inducement or motivation to take a particular action, such as wages for labor.
• Competition occurs among suppliers or buyers, protecting consumers from exploitation, promoting efficiency and growth, and rewarding successful suppliers with profit.
• Negotiation happens between buyers and sellers.
• Market capitalism is a type of ownership characterized by private ownership of the factors of production.
• Market prices indicate to both consumers what they need to sacrifice to buy a good or service and indicate to factor owners how to best use these factors..

The Mixed Economy

• The mixed economy combines features of tradition, command, and the market, with one of the three coordinating mechanisms usually dominating.
• All economies are mixed.
• Property rights are primarily private but may involve public ownership of the factors of production.
• Coordination is done by either the market or the state, varying based on debate and time.

Imperfect Competition

• Imperfect competition a market where individual buyers and sellers influence prices.
• It exists in industries with more than one firm and where at least one firm is a price setter, possibly through monopolistic competition or oligopoly.
• Individual firms are affected by their competitors' actions.

Nationalization

• Nationalization means transferring ownership of assets from the private to the public sector (government), with or without compensation.
• It can result in large bureaucracies, inefficiency, and political interference.
• The opposite of privatization.

Perfect Competition

• Perfect competition assumes that many firms produce identical goods consumed by many buyers.
• No buyer or seller can influence the price, which is determined by supply and demand. All participants must accept the price.
• Opposite to imperfect competition.

Privatization

• Entails transferring ownership of assets from the public to the private sector, often to address funding concerns, improve asset efficiency, and reduce budget deficits from inefficient public enterprises.
• The modern trend is towards it.
• The opposite of nationalization.

Adam Smith

• Emphasized the division of labor, free trade, and a limited government role as key to wealth.
• Argued that individuals should be free to pursue their own self-interest, with the market acting as an "invisible hand" to promote national interest.
• The division of labor involves breaking up production into separate steps, allowing each worker to focus on a particular task, which saves time, allocates work to the best suited individuals, develops specific skills, allows mechanization, and improves output quality. It can lead to worker alienation and process interdependence.

Karl Marx

• Marx argued that labor was the source of all wealth.
• Believed labor was exploited by capitalists because workers' contributions exceeded their wages.
• Capitalism would lead to its own destruction and be replaced by a classless system through revolt.

Keynes

• Keynes believed that markets should function freely without government intervention.
• Government should stimulate demand goods and services using expansionary fiscal policy.
• Fiscal policy measures include increased government spending or decreased taxes.