The Price System

Economic Systems are divided into three major types:

a. Market Economy
It is known as a free enterprise economy where consumers determine what is produced, how resources are allocated, through the price mechanism (prices act to indicate the market value of a particular resources), also land and capital are privately owned. There’s consumer sovereignty in this economy because:

• Consumers signal their preferences through their price mechanism.
• Prices and self-interest of people and businesses act as a guide to the decisions that have to be made.
• The higher the price offered will encourage firms to produce more.
• Resources switch from products that are becoming less popular to those which are becoming popular, so a commodity in:

 
Short supply but the demand is high will result in high price

High supply but the demand is low will result in low price

A market economy should be very responsive to changes in consumer’s demand. It is originated from Adam Smith (1723-1790) he suggested that all of the decisions should be left to private. The term ‘invisible hand’ used to describe that it brings together both private and social interest in a harmonious way as in they work together harmoniously. Government role is very limited in this type of economy.
There are strengths and limitations of market economy.

                                                   STRENGTHS!

• People are given freedom without restrictions to own factors of production (land, labour, capital, enterprise)
• Those who earn the highest income exercise the maximum influence.
• Those whose skills are in highest demand and the most successful entrepreneur will be able to buy more products.
• Consumers can choose which firms to buy the products from.
• Firms can decide which product to produce according to what they and consumers want.
• Workers can choose whom to work for.
• The private motive and competition promote efficiency as the aim of firms is to gain as much profits as possible.
• High income provides an incentive for people to work hard and for entrepreneur to set up and expands firms.
• Everyone will give their best performance I order to control economic resources as much as possible.

                                                      LIMITATIONS!

• Government intervention is minimum, because the factors of production are owned by private sector.
• Firms need to achieve the least cost of method of production (labour or capital intensive) it depends on the country’s situation and condition.
• Firms who don’t change their output quickly to reflect what is in demand and have high costs are likely to go out of business.
• Those who have low skills will not be able to compete with others who have high skills.

b. Planned Economy

 
It is an economy where the government make the crucial decisions where land and capital are state-owned. Resources are allocated by directive (instructions given by the state to the state-owned enterprise). It can also be called a centrally planned/command/collectivist economy. Its emphasis is on centralisation as it can be described to be one of sacrificing current consumption and standard of living in order to achieve enhanced future wellbeing.
In this economy, government is responsible to:

• The allocation of resources.
• The determination of production targets for all sector of the economy.
• The distribution of income and determination of wages.
• The ownership of most productive resources and property.
• Planning the long-term economic growth.

Some of these decisions above have to be decentralised, either geographically or by sector, to government organisations.
The outcome of the planned economy is that central planning tends to set goals for the economy that differ from those of the market economy.
This planned economy has its strengths and limitations as well:

STRENGTHS!

• There’s economic equality.
• The state provides training and education.
• The welfare of everyone is equal, hence unemployment is not an issue.
• People don’t need to be busy, getting involved in the economy of the country as the one who ruled the economy is government.

LIMITATIONS!

• Most of the economic resources owned by the government.
• It is rule by government alone.
• No consumer sovereignty.
• No private enterprises.
• People can’t participate in doing economic activity more creative and free, hence new innovations are becoming less.
• This type of economy is most likely to exist only in theory, not in the reality.

c. Mixed Economy

It is an economy in which both private and public sectors plan some important roles. Some firms are privately owned (in the private sector) and some owned by government (in the public sector).
In this economy, government is responsible for:

• Substantial areas of public expenditure such as health care, social services, education and defence.
• The direct operation of nationalised industries such as coal, iron and steel, railways, gas, water, telephones, and electricity.
• Providing support for large areas of manufacturing, such as vehicle production, aerospace, and electronics in partnership with the private sector.
• The overall management of the macro economy and funding the particular public and merit goods (goods that have positive externalities such as education, and health care) that could be under-consumed if left to the private sector.

As:

• Government at all levels is an important employer and provides basic services such as education and various types of medical care.
• Government agencies regulate and control he provision of some essential services. Such as energy, telecommunications, and transportation.
• Indirect support is given to various strategically important companies.

The strengths and limitations of this type of economy are:

STRENGTHS!

• Government works together with private sector may give new innovations resulted from creativity of both sector.
• People can participate together with government in doing economic activities.
• Government can discourage the consumption of products that are harmful for consumers and others than they appreciate by imposing taxes.
• Government can finance the production of product that cant be charged directly.
• Government can prevent private sector firms from exploiting consumers by charging high prices.
• Government can help the private sector to produce products that are essential and encourage to be consumed through the give of subsidies, so the price of that products will not be too high and the private sector can produce more.

LIMITATIONS!

• Risks are always attached to mixed economy, either market failure, or there’s another problem (conflict) from both sector to decide on something.
• There’s no guarantee than this economy will perform better than the other two types since it depends on the government and the country itself.
• Market failure can occur and sometimes government intervention may make the situation even worse.