Economic Systems

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The way scarce resources get distributed within an economy determines the type of economic system. There are four different types of Economic Systems; a traditional economy, a market economy, a command economy, and a mixed economy. Each type of economy has its own strengths and weaknesses.

The Four Types of Economic Systems

Types of Economic Systems

1. Traditional Economic System

The traditional economic system is the most traditional and ancient types of economies in the world. Vast portions of the world still function under a traditional economic system. These areas tend to be rural, second- or third-world, and closely tied to the land, usually through farming.

In general, in a traditional economic system, a surplus would be rare. Each member of a traditional economy has a more specific and pronounced role, and these societies tend to be very close-knit and socially satisfied. However, they do lack access to technology and advanced medicine.

2. Command Economic System

In a command economic system, a large part of the economic system is controlled by a centralized power. For example, in the USSR most decisions were made by the central government. This type of economy was the core of the communist philosophy.

Since the government is such a central feature of the economy, it is often involved in everything from planning to redistributing resources. A command economy is capable of creating a healthy supply of its resources, and it rewards its people with affordable prices. This capability also means that the government usually owns all the critical industries like utilities, aviation, and railroad.

In a command economy, it is theoretically possible for the government to create enough jobs and provide goods and services at an affordable rate. However, in reality, most command economies tend to focus on the most valuable resources like oil.

China or D.P.R.K. (North Korea) are examples of command economies.

Advantages of Command Economic Systems

  • If executed correctly, the government can mobilize resources on a massive scale. This mobility can provide jobs for almost all of the citizens.
  • The government can focus on the good of society rather than an individual. This focus could lead to more efficient use of resources.

Disadvantages of Command Economic Systems

  • It is hard for central planners to provide for everyone’s needs. This challenge forces the government to ration because it cannot calculate demand since it sets prices.
  • There is a lack of innovation since there is no need to take any risk. Workers are also forced to pursue jobs the government deems fit.

3. Market Economic System

In a free-market economy, firms and households act in self-interest to determine how resources get allocated, what goods get produced and who buys the goods. This is opposite to how a command economy works, where the central government gets to keep the profits.

There is no government intervention in a pure market economy (“laissez-faire“). However, no truly free market economy exists in the world. For example, while America is a capitalist nation, our government still regulates (or attempts to control) fair trade, government programs, honest business, monopolies, etc.

In this type of economy, there is a separation between the government and the market. This separation prevents the government from becoming too powerful and keeps their interests aligned with that of the markets.

Historically, Hong Kong is considered an example of a free market society.

Advantages of a Free Market Economy

  • Consumers pay the highest price they want to, and businesses only produce profitable goods and services. There is a lot of incentive for entrepreneurship.
  • This competition for resources leads to the most efficient use of the factors of production since businesses are very competitive.
  • Businesses invest heavily in research and development. There is an incentive for constant innovation as companies compete to provide better products for consumers.

Disadvantages of a Free Market Economy

  • Due to the fiercely competitive nature of a free market, businesses will not care for the disadvantaged like the elderly or disabled. This lack of focus on societal benefit leads to higher income inequality.
  • 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.

4. Mixed Economic System

A mixed economy is a combination of different types of economic systems. This economic system is a cross between a market economy and command economy. In the most common types of mixed economies, the market is more or less free of government ownership except for a few key areas like transportation or sensitive industries like defense and railroad.

However, the government is also usually involved in the regulation of private businesses. The idea behind a mixed economy was to use the best of both worlds – incorporate policies that are socialist and capitalist.

To a certain extent, most countries have a mixed economic system. For example, India and France are mixed economies.

Advantages of Mixed Economies

  • There is less government intervention than a command economy. This results in private businesses that can run more efficiently and cut costs down than a government entity might.
  • The government can intervene to correct market failures. For example, most governments will come in and break up large companies if they abuse monopoly power. Another example could be the taxation of harmful products like cigarettes to reduce a negative externality of consumption.
  • Governments can create safety net programs like healthcare or social security.
  • In a mixed economy, governments can use taxation policies to redistribute income and reduce inequality.

Disadvantages of Mixed Economies

  • There are criticisms from both sides arguing that sometimes there is too much government intervention, and sometimes there isn’t enough.
  • A common problem is that the state run industries are often subsidized by the government and run into large debts because they are uncompetitive.
Prateek Agarwal
Prateek Agarwal
Member since June 20, 2011
Prateek Agarwal’s passion for economics began during his undergrad career at USC, where he studied economics and business. He started Intelligent Economist in 2011 as a way of teaching current and fellow students about the intricacies of the subject. Since then he has researched the field extensively and has published over 200 articles.

30 thoughts on “Economic Systems”

      • It seems to me that calling China a command economy is an oversimplification. It has strong market economy elements. Although essentially a dictatorship, the authorities try hard to cater to demands of the population through market pricing. Probably no country an be put into one of your four categories, but China is probably the most difficult to classify,

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        • I completely agree with you but these are the textbook categories used for simplification and countries tend to stick to one economic philosophy

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    • The freer the economy, the better. The less control the government has over the economy, the better. I personally think that Austrian Economics is the best.

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      • To some small extent, wouldn’t Adam Smith dissagree? A completely unfettered market- driven system with no government oversight is just as bad or ‘totalitarian’ as any command economy. It’s about the competence of management and integrity or morality of the “system”, period.
        Thank you for your consideration.

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        • Well than who decides what competent management, integrity, and morality look like? The slippery slope tends to be on the side of the mountain that faces command economies. In other words, government isn’t competent enough to define and determine who’s competent and moral. History has proven that.
          And well, now that i’m thinking about, neither are individuals.
          But there are defining values that humans hold. Humans want to limit the probability of death while raising their options of choice. From there you can through a philosophical rabbit hole, but don’t point is, at those two valued being at the core most people have to act good and humane in order to achieve and sustain those. That’s why the US Constitution is so valuable: it trust that most people will do good in order to pursue those values.

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    • it depends on the country bc each country has different resorse amounts and population interests that can cancel out the disadvantages

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  1. I’m genuinely curious as to if there are any other economic system options out there and which one you advocate for the most as well as why so. So far, the mixed economy system sounds the most advantageous to me because of its flexibility and versatility to combat specific systemic issues as opposed to broad general solutions. I think the key element here is essentially having the freedom of options at your disposal to combat complex problems. From there it’s just a matter of specific fine tuning.

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  2. “Anything to the core is detrimental to its own existence”, this is well known.
    What is killing America is capitalism to the core. There should be a balance, mixed economy that is fair.

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    • The power government has regarding each economic system and its involvement. The government can radically change any economic system in the blink of an eye if you give it that much power

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    • Hi, I’m 17 so take my synopsis as you will. Understand that the command economies and mixed economies tend to have substantially more negative effects than traditional or free market economies. This is because the government controlled industries in command economies (as the author so eloquently summarized) tend to be less capable of understanding price regulations and stockage due to less attention being paid to each individual sector and thus tend to massively overproduce which becomes a root cause of crash and recession as seen in the holodomor era and even occurred in a substantially mixed economy of the U.S. nearing the end of the 1920’s. This is opposed to free market economies because smaller businesses tend to understand stockage and profit at the lower levels than do government and rarely find problems of mass overproduction. As the author said, command economies have a negative effect of squandering innovation, which leads to easier, but usually less eco-friendly, forms of product and production fuel. Tesla is a great example of private enterprise being innovative to help the environment, but you would most likely not find an enterprise similar to Tesla under the command government economy because of its sheer responsibility to respond to almost every sector dividing its ability to act both with speed, efficiency and innovation, where innovation is ultimately sacrificed for the other two which allows for more pollutant style production fuel

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  3. I need to be an economist but i do not have the full information about it. so please someone can help and tell me more about command economic system because I am interested in also help me by telling me what faculty should I take when I registered at university. thank you

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    • Command economies envelope socialism under its general definition. Think about it like this. There is a wide ranged umbrella known as a command economy. Under that umbrella exists different economic systems such as socialism, communism, totalitarian and Marxist systems, Leninism, Maoism, Juchi. They all exist under command economy definitions, but the term command economy is a general term for any system where a centralized power has control of most of the economic sectors (I.E means of production, public health, law enforcement, other consumer related jobs)

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    • Its down to your perspective ultimately but to me it would be between the traditional economy and free market economy. The traditional economy refers to more mercantilist ideology where people will buy and sell and trade between each other and where large retail and consumer business corporations don’t tend to exist but rather small shops and farms for the most part. Bartering is common and you can look to most medieval countries pre-industrial as a reference to what I’m talking about if you still don’t understand. A free Market economy is essentially that but on a larger scale with more innovative technology and large corporations that induce mass labor necessities. Instead of people picking up a trade like traditional mercantile economies, they tend to work in factories and factory lines (industrial revolution style) but that makes for the modern day equivalent of most retail jobs. Both have little government regulation, although in the traditional economy central powers worked to end guilds, and in free market economies governments tend to still have regulations on monopolies

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  4. I’m not an economics or business major, but I have spent fifty years in the workforce. And through my own personal experience, the claim repeated ad nauseam by “free-marketeers” that private business is more efficient and cost effective than a government sponsored utility or program, is a faux- libertarian [utopian] myth. Corporations or ‘corporatism’ took over where ‘capitalism’ left off. And corporations are some of the most redundant and inefficient economic machines on Earth.
    Rule 1. Time is money. Don’t waste my time and I won’t waste your money. Once that element is returned to the equation, from a “labor” perspective, then the rest of the claims might begin to hold a little more water.
    Thank you for your consideration.

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    • Interesting point. However, I politely disagree. The problem with the “corporatism” label is that it loses all value when it is used too lightly. I agree that Capitol Hill and even state powers can be swayed by corporations, but surprisingly enough, the economic class that has been booming the most for the last decade has been the middle class. Entrepreneurship has increased drastically over the last decade and small businesses have been more successful now than ever before. While agrarianism is obviously on the brinks of destruction altogether, it is not being usurped by large scale corporations but rather small, state local businesses. I could name 30 different stores in my county alone that profit more where they are than corporations. The problem is the innovation to efficiency balance that seems to be a repetitive cycle. Small businesses are more appealing because of the content of their items, their background and their overall in person appeal to customers. However, Corporations begin to offer more in bulk at lower prices due to their wealth potential to spend as much as they need to raise a profit. It all boils down to the consumer, but it appears in the last decade more consumerism has swayed in the way of small traditional businesses. Government style programs and economics become immediately inefficient when you replace the corporate and locally owned businesses with them. Of course the government should have a certain amount of power to understand and stop power grabs from companies such as Lockheed Martin, but to go beyond and instill government programs that will either purposely or accidentally knock out private businesses is exactly what brought Russia’s government up during the Stalin reign especially in 1929-33 but if you dig deeper, it destroyed the common populations economy, so much so that they had to turn to cannibalism, theft, murder, emigration. This era is known as Stalins first 5 year plan but is commonly referred to as the Holodomor. I am 17 by the way and I admire the service you’ve done in the workforce and due to my youth you may take my reply with a grain of salt if you wish.

      Reply

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