ECONOMIC SYSTEMS

DVS 1101 INTRODUCTION TO

POLITICAL ECONOMY LECTURE
NOTES
 Economic Systems
• An economic system is a way in which
ownership, control and allocation of resources
is organized in an economy. Every economy has
to accomplish these tasks:
(a) To determine what goods and services are
required
(b) How much of each is/are to be produced
(c) Where/What regions they should be produced
and distributed
 Economic Systems Cont’d
(d) How and in what manner they should be
produced and distributed
• Categorizing economies has always presented
some difficulties and it is assumed that it was
a mistake to suggest that there was a single
universally accepted model of either
capitalism or socialism.
 Economic Systems Cont’d
• The distinction between the two became
unclear when one deals with the realities of
economic activities in most contemporary
economies. In practice, societies have
constructed their own models of socialism and
capitalism depending on their particular
economic and political circumstances.
 Economic Systems Cont’d
• No capitalist system is entirely free of socialist
impurities such as labour laws and welfare
systems and there have been no socialist
system without capitalist impurities such as
market mechanism operations.
• Economic systems can be divided into three
major categories
 Economic Systems Cont’d
i) State planned economy (Command/Centrally
Planned or Controlled economy)
(ii) Capitalist economy (Free Market/Laissez-
Faire Economy)
(iii) Mixed Economy
 (A) Planned/Command Economy
• This is an economic system in which the state
directs the economy. It’s an economic system
in which the central government controls
industry so that it makes major decisions
regarding the production and distribution of
goods and services. It is also referred to as a
command, centrally planned or controlled
economy.
 Planned/Command Economy
• This type of economy existed in the former
USSR, China, Cuba, North Korea and Tanzania
under Ujaama.
• In such economies, central economic planning
by the state or government controls all major
sectors of the economy and formulates all
decisions about the use of resources and
distribution of output.
 Planned/Command Economy
• Planners decide what should be produced and
direct the lower levels of enterprises to
produce those goods and services in
accordance with national and social
objectives.
• A planned economy consists of state owned
enterprises, private enterprises directed by
the state or a combination of both.
 Planned/Command Economy
• Under the command economy, the means of
production are publically owned.
• As already mentioned, in the command
economy, all or most decisions about resource
allocation are made by a central planning
authority. The government fixes the quantity
of each good to be produced and the price at
which it is sold.
 Planned/Command Economy
• It sets quarters for each individual production
unit. It decides how much resources should be
employed in producing goods and services.
The state even decides how each worker is to
specialize. Such a government believes that it
knows best how to organize, distribute and
coordinate a country’s resources.
• Communist economies are command
economies.
 Planned/Command Economy
• In such a planned economy, economic
efficiency depends on the accuracy of the
government plans in forecasting societies’
wants and allocating resources to meet them.
• More often, the chosen output may be
inefficient e.g. if the prices of certain
consumer goods are set at a lower level than
the free market price for ideological reasons.
 Planned/Command Economy
• In a communist economy, people have limited
freedom if any in their economic decisions but
in return they have greater security and
equality because basic necessities are made
available to everyone at a price fixed by the
government that they can all afford but they
are frequently shortages of consumer goods
which limit people’s choices.
 Advantages of Command/Planned
Economy
• It ensures proper allocation of resources
• There is price and economic stability which can
lead to rapid economic growth e.g. China
• Maximization of social welfare due to public
ownership
• The state gets full control and is able to
implement economic plans effectively.
• It reduces income inequalities and unequal
distribution of resources.
 Advantages of Command/Planned
Economy Cont’d
• The production and consumption of
undesirable goods (demerit goods) can be
prevented
• Public goods e.g. roads, bridges, schools and
merit goods can be produced since production
in a planned economy is not for profit motive.
Disadvantages of Command Economy
• With state controlled price systems, it
becomes impossible to judge on the house
holds’ demands and so what is produced
might not be what the house hold wanted.
• Central planning usually involves large
bureaucracies which are wasteful of labour
resources. At times large bureaucracies are
ineffective in planning
 Disadvantages of Command Economy
• The coordination and management of large
scale economic plans is difficult in practice
because of the economic scale of the
undertaking
• Government ownership of the means of
production lessens/reduces the
initiatives/incentives of individuals. This
reduces innovativeness and productivity due
to absence of profit motives
 Disadvantages of Command Economy
• There is no consumer sovereignty and
therefore freedom of choice is violated.
• There is absence of competition in a command
economy which is a disincentive to efficiency
and productivity.
• Centrally planned economies lack democratic
institutions and tend to be undemocratic.
B) Market Economy/Capitalist/Laissez Faire
Economy
• Capitalist free market economy is a complete
opposite to a command economy because
economic decisions are left to individuals. The
allocation of resources is a result of countless
individual decisions by producers and
consumers in the market place. There is no
direct role for government/state in the
allocation of resources.
 Market Economy/Capitalist/Laissez Faire
Economy
• In a capitalist economy, price acts as a signal
to both producers and consumers. It indicates
what, when and how much firms should
produce to maximize their profits and how
much consumers should buy to satisfy their
wants. If the price is too low, consumers will
demand more than what is produced and the
price will rise and vice versa.
 Market Economy/Capitalist/Laissez Faire
Economy
• The price mechanism therefore ensures
efficiency in the allocation and use of
resources. In this system, there is freedom of
choice in that individuals are free to buy and
hire economic resources, to organize these
resources for production and to sell their
products in the market of their choice.
Because of this, individuals are free to enter
and leave any industry.
 Market Economy/Capitalist/Laissez Faire
Economy
• Producers are motivated by profits in their
production decisions.
• Thus, in a market economy, quantities
produced, prices and resource allocation are
all market determined and oriented.
• However, a free market economy might create
unsatisfactory outcomes for how wealth is
distributed, what goods are produced and
how they are produced.
 Advantages of Market Economy
• Good quality products are likely to be
produced since in free market economy, there
is competition which encourages
improvement in quality of products.
• It does not require personal monitoring and
thus costs of administration are reduced.
• It provides an incentive to work hard and
efficiently through price and profit signals.
 Advantages of Market Economy
Resources go to those who can utilize them
better.
• Goods and services may be available to
consumers at cheap prices since individuals
are not forced to buy goods which they cannot
afford especially if they are not essential
goods.
• There is flexibility in production depending on
profitability.
 Advantages of Market Economy
• Consumer sovereignty is promoted. Producers
produce goods which consumers buy more.
• There is no resource wastage
• There is technological advancement, efficiency
and a culture of time management.
• Preferences of consumers are satisfied
Disadvantages of Market Economy
• Since all resources are only available of their
prevailing market prices, some members of
the communities might be badly deprived of
the basic necessities of life.
• It might result to a very unsatisfactory socially
unacceptable distribution of income (unequal
distribution of income)
Disadvantages of Market Economy
• Some desirable products and services may not
be produced for lack of profitability e.g.
construction of roads, health centres e.t.c.
• Some undesirable products may be produced
e.g. dangerous addictive drugs.
• Competition may lead to wastage of resources
e.g. excessive advertising
Disadvantages of Market Economy
• Private wealth may be maximized at the
expense of others. Where such inequalities of
wealth exist, resources may be allocated to
production of luxurious goods to the exclusion
of necessities of the poor.
• Some vital services e.g. police, courts of laws,
fire services e.g. would not be provided by
private enterprises and must be provided by
the government.
Disadvantages of Market Economy
• Some key goods and services such as health
and education might be provided in
inadequate quantities in a free market
economy and provision of these goods by the
state will be necessary to create them in
adequate quantities.
 C) MIXED ECONOMY
• This is the system which combines competitive
private enterprises with some degree of
central control.
• The disadvantages of either an entirely
command economy or free market economy
suggests that a certain amount of government
planning is valuable despite the problems of
the controlled economy.
 MIXED ECONOMY
• This is a Mixed Economy where some
resources are owned by the state/government
and others by the private individuals.
 Features of Mixed Economy
• Resources are jointly owned by government
and private individuals. The state plays more
decisive role in all third world economies than
the developed countries.
• LDCs mixed economies are characterized by
the roles of both private sector and state in
allocation and distribution of resources.
 Why State Intervention in a Free Market
Economy?
• To restrain the unfair use of economic power
by monopolies or other bodies who might be
able to impose their wishes on the rest of
society.
• To correct the inequalities of free market
system distributing wealth between
individuals and regions.
 Why State Intervention in a Free Market
Economy?
• Provide goods and services that private
enterprises would be reluctant or unable to
provide in sufficient quantities and at
acceptable price e.g. special equipment for
handicapped people, armed forces and the
provision of electric and railway systems.
 Why State Intervention in a Free Market
Economy?
• To remove socially undesirable consequences
of private production e.g. pollution control,
regional imbalances, unemployment e.t.c
• To direct change in the structure of the
country’s industry (ies) giving aid to new
industries, giving tax holidays, investment in
research and development e.t.c
 Why State Intervention in a Free Market
Economy?
• Manage inflation rates, employment levels,
balance of payments and the economic
growth rates in accordance with social
objectives.
• To moderate the ups and downs in the trade
cycle e.g. trying to stimulate demand for
goods and services, stabilization of prices e.t.c
 Why State Intervention in a Free Market
Economy?
• The result is that there are no purely capitalist
economies or communist economies for that
matter and that most economies are
somewhere in the middle. Most western
economies are therefore “Mixed” with a large
private sector but a substantial government
role in the economy.
• N.B: The mix of the economy is determined
by:
 Why State Intervention in a Free Market
Economy?
• The political outlook of its government and
people and their attitude to the distribution of
resources in their society
• The need for public goods i.e. goods and
services that should be shared collectively by
the general public and cannot be provided to
individual customers such as defense.
 Advantages and Disadvantages of Mixed
Economy
• Advantages and Disadvantages of Mixed
Economy [Look at the advantages and
disadvantages of both economic systems i.e.
market economy and command economy. A
mixed economy combines both economic
systems]
 Why most developing economies are
mixed?
• The need for provision of goods and services that private
enterprises are unable to provide in sufficient quantities and
at affordable price e.g construction of roads, provision of
security forces and the provision of electricity influences state
control of the otherwise free market economy in order to
ensure the less privileged population are offered these
services.
• Due to a low level of income in developing countries, the state
aims at minimizing wastage of resources which would result
as a result of competition in a free market economy.
• To remove socially undesirable consequences of private
production e.g. pollution control, regional imbalances,
unemployment e.t.c, the gov’t has to regulate the country’s
• There’s always need for the state intervention to reduce
the highly un acceptable un equal income distribution.
• Management of inflation rates and price stabilization in
favor of the low-income earners becomes the role of
the state as most of its citizens would be affected by a
free market economy.
• The element of a free market economy in a mixed
economic system increases innovativeness and
productivity due to presence of profit motives. This
boosts the country’s development.
• The coordination and management of large-scale
economic plans becomes easier due to presence of
profit motives which also boosts development.
• The intervention of government in markets helps in
promoting target industries by reducing barriers to entry
in an attempt to achieve comparative advantage.
• Governments may seek to redistribute wealth by taxing
the private sector, and using funds from taxes to
promote social objectives.
• Trade protection, subsidies, targeted tax credits, and
public-private partnerships help to boost development.
• In developing countries, state regulations are necessary
to direct change in the structure of the country’s
industry (ies) e.g giving aid to new industries, giving tax
holidays, investment in research and development e.t.c
 Guiding Questions
1. (a) What is an economic system?
(b) Distinguish between a Command Economy
and Market Economy
2) Discuss the merits and demerits of a Centrally
Planned Economy
3) Discuss the merits and demerits of a Free
Market Economy
 Guiding Questions
4 (a) What is a Mixed Economy?
(b) Why are most economies in the developing
countries mixed in nature?
5) Account for government intervention in a free
market economy
6) What type of economy is Uganda’s economy?
Give reasons for your answer.
 Guiding Questions
7) If you are to be a Presidential adviser on
economic affairs, which type of economic
system would you recommend to Uganda and
why?