Economic Systems | Macroeconomics (2024)

Learning Objectives

Describe characteristics of market economies, including free and competitive markets
Describe characteristics of a planned, or command, economy

Figure 1.Perhaps a picture of a planned economy?

TypesofEconomies

In the modern world today, there isa range of economic systems, from market economies to planned (or command) economies.

Market Economies

Amarketis any situation that brings together buyers and sellers of goods or services. Buyers and sellers can be either individuals or businesses. In amarket economy, economic decision-making happens through markets. Market economies are based onprivate enterprise:the means of production (resources and businesses) are owned and operated by private individuals or groups of private individuals. Businesses supply goods and services based on demand. Which goods and services are supplied depends on what products businesses think will bring them the most profit. The more a product is demanded by consumers or other businesses, the higher the price businesses can charge, and so the more of the product will be supplied. Consumer demand depends on peoples’ incomes.A person’s income is based on his or her ownership of resources (especially labor). The more society values the person’s output, the higher the income they will earn (think Lady Gaga or LeBron James).

Examples of free-market economies include Hong Kong, Singapore, and to a large extent,New Zealand, and the United States.

Free Markets

In amarket economy, decisions about what products are available and at what prices are determined through the interaction of supply and demand. Acompetitive marketis one in whichthere isa large number of buyers and sellers, so that no one can control the market price. Afree marketis one in which thegovernment does not intervene in any way. A free and competitive market economy is the ideal type of market economy, because what is supplied is exactly what consumers demand.

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Planned (or Command) Economies

Figure 2. Ancient Egypt’s command economy forced people to work on the building the pyramids.

Command economies operate very differently. In acommand economy, economic effort is devoted to goals passed down from a ruler or ruling class. Ancient Egypt was a good example: a large part of economic life was devoted to building pyramids (like the oneat the left), for the pharaohs. Medieval manor life is another example: The lord provided the land for growing crops and protection in the event of war. In return, vassals provided labor and soldiers to do the lord’s bidding. In the last century, communist countries have employedcommand economies.

In a command economy, resources and businesses are owned by the government. The government decides what goods and services will be produced and what prices will be charged for them. The government decides what methods of production will be used and how much workers will be paid. Some necessities like health care and education are provided for free, as long as the state determines that you need them. With the collapse of the former Soviet Union in the 1990s, command economies fell out of favor as an economic system.Currently, onlyNorth Korea and Cuba have command economies.

The primary distinction between a free and command economy is the degree to which the governmentdetermines whatcan be produced and what prices will be charged.In a free market, these determinationsare made by the collective decisions of the market itself (which is comprised of producers and consumers). Producers and consumers make rational decisions about what will satisfy their self-interest and maximize profits, and the market responds accordingly. In a planned economy, the government makes most decisions about what will be produced and what the prices will be, and consumers react passively tothat plan.

Most economies in the real world are mixed; they combine elements of command and market systems. The U.S. economy is positioned toward the market-oriented end of the spectrum. Many countries in Europe and Latin America, while primarily market-oriented, have a greater degree of government involvement in economic decisions than inthe U.S. economy. China and Russia, while they are closer now to having a market-oriented system than several decades ago, remain closer to the command-economy end of the spectrum.

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Watch It

The following Crash Course video provides additional informationabout the broad economic choicesthat countries makewhen they decidebetween planned and market economies. The narrators talk fast, so you’ll need to listen closely and possibly watch the video a second time!

You can view the transcript for “Economic Systems and Macroeconomics: Crash Course Economics #3” here (opens in new window).

Economic systems determine the following:

What to produce?
How to produce it?
Who gets it?

In a planned economy, government controls the factors of production:

In a true communist economy, there is no private property—everyone owns the factors of production. This type of planned economy is called a command economy
In a socialist economy, there is some private property and some private control of industry.

In a free-market (capitalist) economy, individuals own the factors of production:

Businesses produce products.
Consumers choose the products they prefer leading the companies that produce them to make more profit.

Even in free markets, governments should

Maintain the ruleof law
Createpublicgoods and services such as roads and education
Step in when the market gets things wrong (e.g., setting minimum wage, establishingenvironmental standards)

Glossary

command economy:: an economy where economic decisions are passed down from government authority and where resources are owned by the government
competitive market:: is one in whichthere isa large number of buyers and sellers, so that no one can control the market price
free market:: a market in which thegovernment does not intervene in any way
market economy:: an economy where economic decisions are decentralized, resources are owned by private individuals, and businesses supply goods and services based on demand

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I'm an economic expert with a deep understanding of various economic systems, particularly market economies and planned (or command) economies. My expertise is backed by a comprehensive knowledge of economic theories, historical examples, and the intricacies of how these systems function. Let's delve into the concepts covered in the article.

Market Economies: In a market economy, economic decision-making is driven by the forces of supply and demand within markets. Private individuals or groups own and operate the means of production, such as resources and businesses. The production of goods and services is based on demand, and businesses supply what consumers or other businesses desire to maximize profit. Notable examples of free-market economies include Hong Kong, Singapore, New Zealand, and the United States. In a competitive market, there is a multitude of buyers and sellers, ensuring that no single entity can control prices. A free market, idealistically, is one where the government does not intervene, allowing the market to determine prices and allocations.

Planned (or Command) Economies: Contrastingly, in a command economy, economic decisions are centralized and directed by a governing authority, be it a ruler, ruling class, or the government itself. Resources and businesses are owned by the government, and it decides what goods and services will be produced, the prices for them, the methods of production, and worker wages. Ancient Egypt and communist countries from the last century, like the former Soviet Union, serve as historical examples of command economies. Currently, only North Korea and Cuba maintain command economies. The primary distinction lies in the extent to which the government influences production and pricing decisions.

Mixed Economies: Most real-world economies are mixed, incorporating elements of both command and market systems. The United States, for instance, leans toward a market-oriented system, but many countries in Europe and Latin America have more government involvement in economic decisions. China and Russia have transitioned toward more market-oriented systems but still exhibit characteristics of command economies.

Economic Systems and Decision-Making: The article emphasizes that economic systems determine what to produce, how to produce it, and who gets the produced goods and services. In planned economies, the government controls factors of production, whereas in free-market economies, individuals own these factors, leading to decentralized decision-making. The role of government, even in free markets, includes maintaining the rule of law, creating public goods and services (like roads and education), and intervening when necessary (e.g., setting minimum wage or establishing environmental standards).

Glossary: The glossary provides clear definitions of key terms, including command economy, competitive market, free market, and market economy, enhancing the reader's understanding of the concepts discussed in the article.

Feel free to ask if you have any specific questions or if you'd like further elaboration on any of these economic concepts.