Eastern Africa Statistical Training Centre (EASTC)

BASICS OF MICROECONOMIC (STT05103)

ECONOMIC SYSTEM
 Economic system
 Every society needs to develop an economic
system.
 An economic system is a particular set of
institutional arrangements and a coordinating
mechanism to respond to the economizing problem.
 In other words, it is the society’s way of
coordinating the production and consumption of
goods and services.
 The economic system has to determine what goods
are produced, how they are produced, who gets
them, how to accommodate change, and how to
promote technological progress.
 Economic system....
Economic systems differ as to:
 Who owns the factors of production
 The method used to motivate, coordinate, and
direct economic activity.
The economic system has two polar extremes:
 The command system and
 The market system
Types of economic system

A traditional
economy
A command economy
A market economy
A mixed economy
 Traditional system
 Traditional system is also known as subsistence
economy
 Traditional systems focus more on goods, services,
and work, and they are influenced by traditions and
beliefs.
 Custom and tradition dictate what to produce, how to
produce it, and for whom to produce.
 Hunting, fishing and farming are the main economic
activities in such an economy .
Although traditional economies are rare in the 21st
century, some still exist (e.g., in Papua New Guinea,
 Traditional system: Resource
allocation)

The allocation of resources in this

traditional economy ( WHAT, HOW, and
FOR WHOM to produce) are determined
by customs and tradition.
 Advantages of Traditional system
Keeps the Traditions and Customs Alive
In traditional countries, people preserve skills
and art within respective communities, tribes,
and families.
Less threat to environment
The traditional economy offers less of a threat to
the environment than other systems. People in
the economy have conventional occupations like
farming, fishing, hunting or cattle-rearing.
 Advantages of Traditional System
• No Wastage of Goods: Since the goods are
produced only to meet the requirements of the
community, tribe, or family, there is no
surplus.
• Skilled and Talented People: Natives make a
living out of skills acquired from family and
community. Over centuries, these communities
have become highly skilled in a particular
niche.
Disadvantages of Traditional system..
• Starvation: People may starve from food
shortage if there is a lack of agricultural,
hunting, or fishing produce.
• Risk of Exploitation: Developed economies
often invade underdeveloped economies to
exploit the land and natural resources.
Disadvantages of Traditional system..
• Limited Growth Opportunities: These economies
focus on preserving tradition and customs—
development of new production and distribution
methods take a back seat. Economic progress is
stagnant.
• Poor Medical Amenities: Due to limited exposure
to the outside world, conventional economies lack
modern medical facilities. As a result, infant
mortality rates are high, and average life
expectancy is very low.
Disadvantages of Traditional system
• No Global Interaction: By being disconnected from
other economies, traditional countries miss out on
trade relations, exchange of culture, and the
development of new techniques.
• Technologically Backward: Traditional countries
rely heavily on an old-school production. They miss
out on new techniques that can increase production,
leisure time, and cost-efficiency.
Extinction of Natural Resources: Economies that
are highly dependent on natural reserves for food,
shelter, and clothing fail to develop alternative
sources. They risk natural resources becoming scarce.
 Command economy
The command system is also known as
planned, socialism or communism.
In this economic system the government owns
most property resources and economic
decision making occurs through a central
economic plan.
The government makes nearly all the major
decisions concerning the use of resources, the
composition and distribution of output, and the
organization of production.
Command economy….
The government owns most of the
business firms, which produce according
to government directives.
The division of output between capital
and consumer goods is centrally decided.
Examples: North Korea and Cuba
Command economy….
The government owns most of the
business firms, which produce according
to government directives.
The division of output between capital
and consumer goods is centrally decided.
Examples: North Korea and Cuba
Advantages of Command economy
Full employment: The Central Planning
Authority (CPA) may enable the achievement
of full employment of resources by directing
labour to production activities even if those
activities are not profitable.
Minimum waste of resources: Government
possess the information to be able to direct
resources where they are most needed since it
operates in the interest of the public.
Advantages of Command economy
Greater ability to tackle externalities: The CPA
operating in the public interest is well placed to take
negative externalities, such as environment pollution
into account when deciding upon the pattern of
production.
Minimum inequalities of income and wealth: As the
government determines the prices of factors of
production, it is able to minimize inequalities in the
distribution of income and wealth
Advantages of Command economy

Low rate of inflation: given that the command

economy is characterized by a whole range of
administered prices for goods and services, a
much lower rate of inflation can be maintained
than in an economy subject to price
mechanism.
 Disadvantages of Command economy

Possible lack of incentive: in this system with

administered prices and wages and the absence
of profits, workers and managers may lack such
motivations
Restricted choice: the goods produced tend to
be standardized with practically no regard for
individual tastes. This limits freedom of choice
for consumers .
Disadvantages of Command economy
Lags in the implementation of plans: there is
a time-lag between the collection of
information and the formulation of production
plans based upon that information. Then, there
is a further time-lag between the
implementation of production plans and the
realization of production targets.
Conflicts of interests can arise because what
the country needs may not be what the people
want
 Market economy
The market economic system is also known as
capitalism.
The system is characterised by the private
ownership of resources and the use of markets
and prices to coordinate and direct economic
activity.
 Individuals and businesses seek to achieve
their economic goals through their own
decisions regarding work, consumption, or
production.
 Market economy...
 Goods and services are produced and resources are
supplied by whoever is willing and able to do so.
 The high potential monetary rewards create
powerful incentives for existing firms to innovate
and entrepreneurs to pioneer new products and
processes.
 In this system, the government is not the dominant
economic force in deciding what to produce, how to
produce, and who will get. The force in this system
is the market.
 Examples: Mexico, United States etc.
Market economy...
 Goods and services are produced and resources are
supplied by whoever is willing and able to do so.
 The high potential monetary rewards create
powerful incentives for existing firms to innovate
and entrepreneurs to pioneer new products and
processes.
 In this system, the government is not the dominant
economic force in deciding what to produce, how
to produce, and who will get. The force in this
system is the market.
 Examples: Mexico, United States e .t.c.
Advantages of Market economy
This economy gives people strong
financial incentives for producing goods
that other people want.
There is an incentive for constant
innovation as companies compete to
provide better products for consumers.
Businesses invest heavily in research and
development.
Disadvantages of Market economy
Since the market is driven solely by self-
interest, economic needs have a priority
over social and human needs like
providing healthcare for the poor.
Consumers can also be exploited by
monopolies.
Resource conservation is a challenge for
market economies.
Income inequality is inevitable
 Mixed Economy
 Both the government and individuals play important
roles in deciding how much to produce and what to buy
 The government owns most of the means of
production but private ownership and foreign
investment is allowed and encouraged.
 Government plans still exist and it maintains power
over its enterprises , but the market forces of supply
and demand are much more prevalent and planning is
more decentralized.
 Government intervenes to redistribute income through
progressive taxes, setting ceiling prices for necessities
and setting minimum wages.
 Mixed economy....
Even though the government intervenes in
the hour of need, it still provides incentive to
the private sector
Governments in mixed economies encourage
private sector to take on public sector
enterprises that are not running efficiently or
can be better run by the private sector.
It enables the government to act as a
regulator rather than a business entity.
Mixed economy....
Governments in mixed economies often
provide environmental protection,
Maintenance employment standards, A
standardized welfare system,
Maintenance of competition.
Mixed economy (Resource Allocation)
The decisions of What to produce is
determined partly by consumer preference and
partly by the government.
The decisions of How to produce is determined
partly by producers seeking profit and partly by
the government.
The decisions for Whom to produce is
determined partly by purchasing power and
partly by the government.
Advantages of mixed economy
Incentives for inventions and product
methodology: More inventions and more
efficient products are produced in the free
market. Less government intervention that
exists in this economy than a command
economy, results in private businesses that
can run more efficiently and cut costs
down than a government entity might.
 Advantages of mixed economy
Both public and private sectors can survive:
A mixed economy offers better options for not
only private business growth but also public
sectors to manage the economy without loss.
Public sectors like energy, defence etc. and
many others are totally run by the government
and the private sector run their businesses on
their own without any government interference
but state government encourages the private
sector to provide better facilities to make
nations economy strong.
 Advantages of mixed economy
Consumer supremacy is maintained: The
consumer has the power to freely buy any goods or
product of their own choices and needs. These
goods can be produced by only the private sector
according to consumers’ needs.
Government control on ownership: Sometimes
private business owner gains more profit by
increasing the prices of goods without supplying
quality output to the consumers. This kind of
monopoly is controlled by the government through
ensuring the customers maximum benefit.
Disadvantages of mixed economy
Unclear government control: The aim of
the private sector is to get maximum profit
out of their business which is sometimes
against the planning of the national
planning system done by the government.
Under the National plan, any private has to
follow their guideline to run their business
which they find difficult to follow.
Disadvantages of mixed economy
Produces high taxation responsibilities.
The state is responsible for public-sector services
that make the marketplace accessible to
consumers and producers. That means it needs
financial support that comes from these two
entities. The most common method of achieving
this result is through taxation. The mixed
economy will tax companies and individuals at
different levels, with more government
involvement often dictating a higher level of
responsibility in this area.
Disadvantages of mixed economy
No freedom to private sector
 There is no freedom to private sector in mixed
economy. This is because Government regulates
private industries through its various regulations
and licensing.
Unemployment and Uncertainties
 On account of capital scarcity, Government
regulation and control, the growth of private
sector may be less than what is fixed in plan. It
may lead to unemployment and uncertainties in a
mixed economy.