Economic Systems: Traditional, Command, & Market Economies

Chapter 2: Economic Systems

• This chapter aims to outline the central economic questions, define the differences between traditional, command, market, and mixed economies.
• Describe the features of a market economy
• Summarize the contributions of Adam Smith, Karl Marx, and John Maynard Keynes to economic science.

Central Economic Questions

• Output questions involve determining what goods and services to produce, and in what quantities.
• Input questions address how goods and services will be produced, and how many scarce resources are needed to produce each good.
• Distribution questions focus on who will receive the goods and services, how much they will receive, and where production will occur.

Traditional Economic System

• Goods are produced and distributed in the same manner across generations.
• Tasks and production methods are determined by customs.
• Techniques of production are handed down from previous generations.
• Production distribution follows long-established traditions.
• This system provides clear answers to the central economic questions but is rigid and resistant to change and innovation, and is often a subsistence economy.
• Economic activity is secondary to cultural and religious values aimed at maintaining the status quo.
• It is now rare and limited to isolated, self-sufficient communities, but tradition remains important.

Command Economic System

• Planners must devise solutions to the three central economic questions, and direct every resource within the economy.
• Lack of incentives may result in lower productivity.
• China's economy improved after incorporating private initiative and market mechanisms into its economic system.

Market Economic System

• It is a spontaneous system where individual self-interest guides the economy.
• The market mechanism guides behavior to solve basic economic questions efficiently.
• Economic activity is driven by self-interest, and economic agents respond to monetary incentives.
• There are no central planners and decisions are not dictated by tradition or authority.
• The system is flexible and promotes economic growth but may exhibit instability and perpetuate inequality.
• For a functioning market, there must be at least one buyer and one seller, the seller must have a product to sell, and the buyer must be able to purchase it.
• An exchange ratio or market price must be determined.
• Agreements must be guaranteed by law or tradition.

Mixed Economy

• Economic systems are a combination of traditional behavior, central control, and market dynamics.
• They are usually described as mixed systems, and are dominated by at least one the three mechanisms.
• Balancing the market mechanism with government intervention, private sector with the public sector remains a critical issue.
• The proportional mix of government involvement and market forces depends on society’s issues, and can change over time.

South Africa’s Mixed Economy

• Private property, initiative, self-interest, and market mechanisms play key roles.
• It includes substantial government intervention.
• Direct state interference in economic decisions of consumers and producers is generally absent.
• Consumers and producers operate freely leaving production to privately owned firms.
• The government participates as a buyer, seller, employer, and regulator, restricting freedom for consumers and producers.
• Some call for less intervention, while others advocate more to combat poverty and historical inequalities from the apartheid era.
• Price controls are an area of government intervention.
• Prices are traditionally established through market mechanisms, this has now changed due to price fixing by the government.
• Most price controls were abolished in the 1980s, petrol still remains regulated by the government.
• There is an assumption of perfect competition in pure market economies.
• Perfect competition is where no single buyer or seller can influence prices.
• Imperfect competition can occur when buyers or sellers influence prices, which justifies government intervention to correct imbalances.
• South Africa's economy does not operate as a pure market system.

Contributors to Economic Thought

• Adam Smith (1723–1790): He advocated for decentralized decision-making, allowing individuals to pursue self-interest and the market acting as an "invisible hand" that promotes the national interest.
• Individuals seeking self-interest through the market mechanism are more efficient than politicians.
• Individuals maximize societal value by producing optimal personal value, which contrasts with the wastefulness and inefficiency of the government.
• Karl Marx (1818–1883): Marx, a revolutionary political scientist, historian, sociologist, and economist, viewed capitalism as a class-based system set to be replaced by a classless structure without private property.
• He opposed economic class structures and promoted the idea that individuals should contribute according to their abilities.
• Individuals also deserve to receive what they need, which was outlined in "The Communist Manifesto."
• John Maynard Keynes (1883–1946): Keynes encouraged private markets to operate without government intervention.
• Problems were due to factors interfering with the market mechanisms, calling for their removal.
• Unemployment was a temporary issue best solved by keeping government, trade unions, and other institutions from interfering with the market mechanism.

Important Concepts

• Tradition
• Command
• Market
• Economic system
• Traditional system
• Command system
• Market system
• Market prices
• Incentives
• Competition
• Negotiation
• Capitalism
• Socialism
• Property rights
• Coordinating mechanism
• Free-market economy
• Mixed economy
• Division of labour
• Money
• Barter system
• Privatisation
• Nationalisation
• Perfect competition
• Imperfect competition