Economic

Systems
FYBBA -2022
Economic System: What is economic system?

 An economic system is a mechanism, which deals with the production,

distribution, and consumption of goods and services in a society.
Economic system: The way society organizes the production,
distribution and consumption of goods and services.
 It comprises of people, institutions and their relationships.
 It addresses problems of allocation and scarcity of resources
Define institutional framework to regulate business environment in a country.
Economic systems adopt different ways to address the questions of allocations/
distribution.
Classification of Economic
Systems

Classification
of Economic
System

Extent of
Ownership of
Market
resources
Mechanism

Mixed Socialism/ Market Mixed Planned

Capitalism
Economy Communism Economies Economies Economies
Three basic types of economic
systems
Free market economy - Capitalist economy
 Planned economy or command economy - communist or socialist
economy
Mixed economy
Features of free market/Capitalist economy

 Freedom of Enterprise:
Private organizations are free to obtain resources or organize production or sell products
in any way they prefer.
This economic system leads to the development of large-scale multinational
organizations.
Every person is free to start any enterprise of his choice.
Private ownership of resource:
 Natural and capital resources like equipment and buildings are owned by individuals and
are not government-owned.
 The goods and services produced in the economy are privately owned.
Features of free market
economy
Features of free market/Capitalist economy

Private property:
Private property is allowed.
 An individual can acquire property and use it according to his will.
Government protects the right to property.
 After the death of a person his property goes to his successors.
 Price mechanism:
 Prices are determined by the forces of demand and supply without any govt intervention.
 The price mechanism helps producer in deciding what to produce, how much to produce,
when to produce and where to produce.
 Economic processes of consumption, production, exchange, distribution, saving and
investment work according to directions of price mechanism.
 Adam Smith: “Invisible Hand” which operates the capitalist system.
Features of free market
economy
Features of free market/Capitalist economy

Consumers’ Sovereignty:
Under capitalism, ‘the consumer is a sovereign king.’ which means freedom of choice by
consumers.
Producers try to produce variety of goods to meet the tastes and preferences of consumers.

Profit motive:
 This is one of the key guiding forces and maximization of profit is the primary concern in this
economy.
 Profit is such an inducement that the entrepreneur is prepared to undertake high risk.
Features of free market/Capitalist economy

Maximized competition:
 Competition is prevalent and dominant throughout the economy.
 Buyers, sellers and producers all compete rigorously with each other.
 The competition leads to efficiency in resource allocation, innovation and profits.

 Conflict of classes:
 The society is divided into two classes the “haves” and “have not’s”.
 Endless tug of war between labour and capital with no solution at hand.

 Absence of a central control or plan:

Resource allocation and investment decisions are influenced by market forces and not by the
government.
Features of free market/Capitalist economy

Limited government intervention:

 Limitations and undesirable outcomes associated with the market system result in an active,
but limited economic role for government.
 To protect the rights of private citizens and maintain an orderly
environment that facilitates proper functioning of markets.
Economic freedom in free
market economy:
 Economic freedom empowers everyone to work, produce, consume and invest as they want.
 The key ingredients of economic freedom are
Personal choice,
Voluntary exchange,
 Freedom to compete in markets, and
 Protection of persons and their property from aggression by others.

 In free market economy, the primary role of govt is protect individuals and
their property from aggression by others.
Free market/capitalist
economies in the world:
 Market economies range from
minimally regulated "free market" systems—where state activity is restricted to providing public
goods and services and safeguarding private ownership to
 interventionist forms where the government plays an active role in correcting market failures and
promoting social welfare.
 Singapore's economy is considered the freest, followed by Switzerland and Ireland,
according to the Heritage Foundation's 2022 Index of Economic Freedom.
Merits of capitalism:
 Efficiency and Optimal Utilization of resources:
Firms in a capitalist-based society face incentives to be efficient and produce goods which are in
demand.
These incentives create the pressures not only to cut costs and avoid waste but produce better quality
products.
 Provides the Best Atmosphere for Innovations:
 Entrepreneurs are always on the look-out for new ideas to be applied to production.
The innovators are suitably rewarded with their royalties, through the copy right.
 Similarly, innovators enjoy the benefits of their research, through the system of patents and trade-
marks.
Complete Freedom of Choice:
 There is no need to direct people or force them.
 Freedom of enterprise and choice of occupation.
Merits of capitalism:
Higher Rate of Capital Formation:
People under capitalism have the right to hold property and pass it on in inheritance to their heirs and
successors.
 Hence, people save a part of their income so that it can be invested to earn more income and leave
larger property for their heirs.
The rate of capital formation increases when savings are invested. This accelerates economic growth.

 High Economic growth:

Entrepreneurs take risks to make higher profits.
They also make innovations in order to cut their costs and maximise their profits.
 Capitalism brings about great technological progress in the country, creates a climate of innovation and
economic expansion.
This helps to increase real GDP and lead to improved living standards.
Demerits of Capitalism:
Monopoly Power:
Private ownership of capital enables firms to gain monopoly power in product and labour
markets.
 Firms with monopoly power can exploit their position to charge higher prices.

 Social Costs are very high and social benefit is ignored:

A profit maximizing capitalist firm is likely to ignore negative externalities, such as pollution
from production. This can harm living standards.
Similarly, a free market economy will under-provide goods with positive externalities, such as
health, public transport and education.
Demerits of Capitalism:
 Monopsony Power:
Firms with monopsony power can pay lower wages to workers.
 In capitalist societies, there is often great inequality between the owners of capital and workers.

 Inequality creates social division:

Societies which are highly unequal create resentment and social division.

 Instability of the Capitalist Economy:

A capitalist economy is inherently unstable. There is recurring business cycle.
 Sometimes there is a slump in economic activity. Prices fall, factories close down, workers are rendered
unemployed. At other times business is brisk, prices rise, there is a good deal of speculative activity.
Demerits of Capitalism:
 Wealth inequality:
The system of private property and the ability to pass on to future generations acts as a means of
increasing inequalities among different classes.
 Those who have wealth can obtain resources and start big enterprises.
 Therefore, capitalist society not only fails to create equality of outcome, but also fails to
provide equality of opportunity.
Free market economies based on
Index of Economic Freedom (2022):
 Singapore
Switzerland
Ireland
New Zealand
 Luxembourg
Taiwan
Estonia
Netherlands
 Planned/Command Economies :
Features of Communism
 The means of production are owned and operated by the government.

The government determines the type, quantity, and price of goods produced.

Communism promises to provide for everyone’s needs.

No social classes: Classless society.

The wealth produced is shared out among the people based on their needs, rather than

on their contribution to the work.

 The decisions made by the society are supposed to benefit the people as a whole, not any individual.
Features of Communism:
 Central plan economy
There is no consumer or producer sovereignty.
Profit is not the main motive, instead the government aims to provide goods and services to
everybody.
 Abolition of Private Property
Elimination of unfair gaps in incomes:
 Each individual is paid compensation according to his need.
The abolition of private profit and interest puts the system of distribution of wealth on just and fair basis.
 There are no unfair gaps between rich and poor.

 Government is responsible for providing work and necessities of life.

Features of Communism:
 It is both a political and an economic system. (E.g: Communist Party of China).
In politics, communist parties have absolute power over governance, and elections are single-
party affairs.
The party controls the country's economic system and no private ownership allowed.
 Since communism provides no incentive for people to work - after all, the central planners will
simply take your products, then redistribute them equally regardless of how much efforts you
put in.
Workers quickly realize that they would not benefit from working harder, so they give up.
Countries that implemented one or another version of communism in the 20th century include
Russia, China, Vietnam, Cambodia, Cuba, and North Korea.
Communist Countries in the
world
North Korea
China
Cuba
Vietnam
Transition in the communist
economies:

 Russia from a communist economy to a mixed economy.

 Cambodia from a communist economy to an open market economy.
 Vietnam from highly centralized command economy to mixed economy.
Communism vs capitalism
 Communism: the government owns the resources or the means of production.
 Capitalism: the resources or the means of production are owned by private individuals.
 Profit: Profit of any enterprise is equally shared by all the people in communism.
 The profit in a capitalist society belong to the private owner only.
 For Communists, the society is above individuals. But for capitalists, individual freedom is
above the state or society.
 Communism stands for abolishing private property, on the other hand Capitalism supports
private property.
Communism vs capitalism
Communism aims for a class less society, which doesn’t see any difference between the rich
and the poor. On the other hand, capitalism divides the society into rich and poor.
While capitalism is a self regulated economic system, communism is a government controlled
economy.
 Capitalism: prices are determined by the market forces.
Communism: Price structure is determined by the govt.
 Capitalist: Every individual has to work for himself to create wealth.
 Communism: Wealth is distributed as per needs and ability.
Contd.
Socialism: What is Socialism?
 Under socialism, the economic system is controlled and regulated by the government so as to
ensure welfare and equal opportunities to the people in a society.
Socialism is an economic system in which the ownership of factors of production is acquired
through a democratically elected government.
Ideology of Socialism is, "From each according to his ability, to each according to his
contribution." Everyone in society receives a share of the production based on how much each
has contributed according to his/her ability. That motivates them to work long hours if they
want to receive more.
 Socialism seeks to redistribute the wealth more equitably.

Socialism is more flexible.

Contd.
Ownership of Resources: In such an economy, all the means of production are owned and
operated by the state in the interest of society as a whole. This is to ensure equality of
opportunities to all the citizens with regard to earning of income. This is also aimed at full and
efficient utilisation of the country’s resources.
Economic Planning: Under socialism, government fixes certain objectives. In order to achieve
these objectives, government adopts economic planning. All types of decisions regarding the
central problems of an economy are taken in the economic plans. There is a Central Planning
Authority, who plans for the economy.
No Competition: Unlike capitalistic economy, there is no cut throat competition. It means lack
of competition as state is the sole entrepreneur.
Contd.
Positive Role of Government:
 Government plays significant role in decision making.
 The government has complete control over economic activities like distribution, exchange,
consumption, investment and foreign trade etc.
Maximum Social Welfare:
The sole objective of socialism is the maximum social welfare of the society.
It means that there is no scope of exploitation of labour class.
Government keeps a close eye on the needs of the poor masses while formulating plans.
Contd.
Work and Wages According to Ability and contribution: Everyone in society receives a share
of the production based on how much each has contributed. That motivates them to work long
hours if they want to receive more.
Communism vs Socialism:
Capitalism vs Socialism:
Mixed Economy
A mixed economy is defined as an economic system blending elements
of market economies with elements of planned economies, free
markets with state interventionism, or private enterprise with public
enterprise.
It is also defined as a mixture of markets with state interventionism.
An economy containing a mixture of private enterprise with public enterprise.

Common to all mixed economies is a combination of free-market principles
and principles of socialism.

Combines capitalism and socialism.

The private sector is a significant component of the Mixed Economy and is
regarded as a critical engine of economic growth.
Contd.
 There is a certain level of economic freedom so that the private sector can
decide the use of capital and seek profits.
It simultaneously allows the government to intervene in some economic
activities and industries. Through providing public goods and collecting taxes,
the government can create more social welfare.
It is a mixture of capitalism and socialism. Under this system there is freedom
of economic activities and government interferences for the social welfare.
Hence it is a blend of both the economies.
The developing countries like India have adopted mixed economy to accelerate
the pace of economic development.
 Even the developed countries like UK, USA, etc. have a mixed economy.
Contd.
Features of Mixed Economy:
 Co-existence of both public sector and private sector: In public sector, industries like
defence, power, energy, basic industries etc., are set up. On the other hand, in private
sector all the consumer goods industries, small-scale industries are developed. The
government encourages both the sectors to develop simultaneously.
 Resource Ownership: In a mixed system, private individuals are allowed to own and
control some of the factors of production.
 State Intervention: Government intervention plays a key role in a mixed economy. This
intervention can take many forms, including subsidies, tariffs, prohibitions and
redistributive policy. Some of the most universally applied mixed economic policies
include legal tender laws, monetary control by a central bank, public road and
infrastructure projects, tariffs on foreign products in international trade.
Contd.
 Personal freedom: It permits adequate freedom to different economic units: (a) Consumers
are free to dispose of their incomes in a manner they want, although the government does try
to influence these decisions through monetary, fiscal policies, (b) Factors of production are
free to choose their own occupations although again the Government may strive to create
conditions favourable for the growth of chosen occupations.
Profit Motive and Social Welfare: there are both profit motive like capitalism and social
welfare as in socialist economy.
Private Property is allowed: It must be ensured that the profit and property may not
concentrate in a few hands.
Price Mechanism and Controlled Price: Under this system, price mechanism and regulated
price operate simultaneously. In consumer goods industries price mechanism is generally
followed. However, at the time of big shortages or during national emergencies prices are
controlled and public distribution system has to be made effective.
Contd.

Economic Planning: In Mixed economy, the Government adopts the instrument of

economic planning. This is necessary for the public sector enterprises which have to
work according to some plan and to achieve certain pre-determined objectives.
 Control of Monopoly power: MRTP Act 1969 (Now replaced by Competition
Act,2002).
Role of Government in mixed
economy
Internalize positive and negative externalities: Government can step in and correct
for the negative effect of the externality by either prohibiting harmful activity or heavily taxing
it. E.g. pollution. Likewise government can give subsidy or state support for goods and services
that create positive externality which tend to be under consumed in a free market. This can
include public goods, like police and national defence, education and health care.
Allows for correction of income inequality:
A mixed economic system can correct such a phenomenon by taxing and redistributing
wealth to the households located at the bottom of the income distribution. At the same time,
it can enable people to enjoy the financial rewards of hard work and entrepreneurship .
 Government takes several measures to reduce the gap between rich and poor through progressive
taxation on income and wealth.
 The subsidies are given to the poor people and also job opportunities are provided to them.
Contd.
Role of Government in mixed economy
Government provides public goods: Roads, education, healthcare, National Defense, Judiciary etc.

Regulates and controls natural monopolies: Railway infrastructure, Gas network, Electricity grids,
Water tap.
Producers and consumer have sovereignty to choose what to produce and what to consume but
production and consumption of harmful goods and services may be stopped by the government.
Government can pursue policies to provide macro-economic stability, e.g. expansionary fiscal policy
in times of a recession.
Social cost of business activities may be reduced by carrying out cost-benefit analysis by the
government.
Role of Government in mixed economy
Government intervenes through price control when price mechanism fails or works against
public interest.
Improving the distribution of income.
Social Security schemes and subsidies
Atal Pension Yojana
Pradhan Mantri Surakasha Bima Yojana
Pradhan Mantri Jeevan Jyoti Bima Yojana
Scenario Today:
Very few societies are purely capitalist or purely socialist/communist.
Most have mixed economies that incorporate socialism with capitalism.
Countries with socialist policies, in combination with a capitalist economy and
democratic political system, include Sweden, Norway, Canada, India and
the United Kingdom.
Socialist policies provide for worker benefits such as vacation time, universal
health care, subsidized child-care, etc.
Is India Moving towards
Capitalism?
Privatisation : NITI Aayog has identified PSUs for strategic sale.
Cement Corporation of India Ltd
 Hindustan Antibiotics Ltd.
Bharat Pumps and Compressors Ltd
Deregulation of fuel prices – reduction in fuel subsidies.
Foreign Institutional Investors are now pumping billions of dollars.
Liberal FDI Norms.
Privatisation of Air India.
Merger/Privatisation of Public Sector banks: Central Bank of India and Indian
Overseas Bank, IDBI.
 Foreign Universities to set up campuses in India.
Contd.
 Stake sale in LIC.
Private ownership has led to India having one of the highest small business
ownership as well as becoming a start-up hub.
However some of the welfare measures as applied to socialistic economies are
still retained such as anti-poverty measures, old age pension schemes and
employment programs. Even in capitalistic countries such welfare measures
exist.
We can say India has adopted a more capitalistic orientation in its mixed
pattern of development.