ECONOMIC SYSTEMS

An economic system is an organization of ownership, allocation and distribution of resources in a given country. The above fundamental economic questions are answered differently depending on the type of economic system. There are three basic types of economic systems which exist in the world today and these are;

a)     Free enterprise/free market/laissez faire/unplanned/ capitalist economy

b)     Centralized/command/planned/socialist economy

c)     Mixed economy.

THE FREE ENTERPISE ECONOMY

Is an economic system where resources are owned, allocated and distributed by private individuals through market forces of demand and supply with little or no government intervention.

CHARACTERISTICS/ FEATURES OF THE FREE ENTERPRISE ECONOMY

ü Resources are owned by private individuals.

ü The price is determined by the market forces of demand and supply.

ü The production of commodities depends on demand.

ü Producers aim at profit maximization and consumers aim at utility maximization.

ü There are many buyers and sellers in the market.

ü There is reliance on price mechanism in the allocation of resources.

ü There is limited or no government intervention especially in resource allocation and decision making.

ü Characterized by self interest.

ü There is freedom of choice. Producers are not forced to produce certain commodities and consumers are not forced to consume what they do not want.

ü Existence of high levels of competition amongst producers and consumers in both factor and commodity markets respectively.

MERITS OF THE FREE ENTERPRISE ECONOMY

1.     There is limited wastage of resources since production is according to demand.

2.     Encourages exploitation of idle resources. This results into creation of more employment opportunities.

3.     Provides an incentive to economic growth. The private ownership of resources facilitates the exploitation and utilization of resources in an economy. This increases the production of goods and services hence economic growth.

4.     Leads to production of better quality products due to competition in production.

5.     Promotes efficient allocation of resources due to competition and the profit motive of producers.

6.     Encourages creativity and innovativeness due to competition in production.

7.     Encourages the growth of entrepreneurship due to the urge to earn high profits.

8.     Consumers enjoy goods at lower prices due to benefits of competitive production. This leads to better standards of living.

9.     Avoids administrative costs by the government because of automatic allocation of resources by the invisible hand.

10. There is low bureaucracy in decision making. This reduces wastage of time and delays because production decisions are quickly made without consulting government offices.

11. Promotes consumer sovereignty. This is because consumers are given freedom to decide on what is to be produced and consumed.

12. Provides a variety of goods and services due to a large number of producers.

DEMERITS OF THE FREE ENTERPRISE ECONOMY

1.     Distorts consumer choices due to persuasive advertisement.

2.     Subjects the economy to economic instabilities such as inflation, instability in balance of payments due to absence of government interference.

3.     Leads to unemployment and underemployment due to closure of some weak firms.

4.     Monopoly is likely to develop with its negative consequences especially exploitation of consumers. Monopolistic firms restrict output and charge high prices with an aim of maximizing profits.

5.     Worsens income and wealth inequalities due lack of a regulatory body. Resource owners tend to accumulate a lot of wealth while the poor grow poorer.

6.     Leads to wastage of resources through excessive advertisement and duplication of goods and services.

7.     Does not provide public goods such as defence, justice and sewage collection and merit goods like education, public health and safe water. This mainly because it would be impossible to charge them prices since “free riders” are not excluded in their consumption.

8.     Some resources may be over exploited leading to their quick depletion and others may remain idle.

9.     Production of goods and services is in favour of the rich (luxury goods) than the poor (necessities). As a result, cheap goods disappear from the market.

10. Results into production and consumption of harmful but profitable goods like alcohol, cigarettes.

11. Does not respond to rapid/ sudden structural changes like flooding, famine, earthquakes which require proper government planning.

12. There is divergence between private benefits and social costs. Under free enterprise economy, private benefits overweigh public benefits. In trying to achieve private benefits, social costs rise e.g. pollution, deforestation, exhaustion of resources, etc.

NOTE

The government intervenes in a free market economy through its policies which include the following;

ü Taxation

ü Subsidization of producers

ü Price legislation (maximum or minimum price)

ü Government planning

ü Rationing of consumers (government provides scarce resources to consumers)

ü Wage determination (minimum wage)

ü Formation of consumer associations through which the government sensitizes people about their rights.

THE COMMAND/COMMUNISM/ CENTRALLY PLANNED/ SOCIALIST ECONOMY

Is an economic system where resources are owned, allocated and distributed by the central authority on behalf of the citizens.

The government creates a department called the central planning authority and this department makes decisions on ownership, control and allocation of resources. Examples of countries that are largely socialist include Russia, China, North Korea, East Germany, Cuba.

FEATURES OF THE COMMAND ECONOMY

ü Economic or productive resources are owned by the state i.e. the state owns all the natural resources and businesses in the country.

ü The economic or productive resources are publicly owned. The productive resources belong to everyone in the country and are used with the guidance of the government.

ü Prices are determined by the state that is by either setting a minimum price to benefit producers or a maximum price to benefit consumers.

ü The main aim of production is to maximize peoples’ welfare. The government does not aim at making profits but producing goods and services that improve peoples’ welfare.

ü Decisions pertaining to economic activities such as resource exploitation are handled by a central planning authority and therefore some resources are reserved for future use.

ü Self reliance is always the major goal of the government whenever economic resources are being designed.

ü There is limited competition in production because the government is not profit motivated and consumers have to wait for what the government is to provide.

ü Extensive planning by the central authority is done. The government is in charge of planning for everything.

MERITS OF THE COMMAND ECONOMY

1.     Income is fairly distributed since resources are publicly owned.

2.     Resources are not wasted since there is effective planning for the economy. Scarce resources can therefore be effectively utilized.

3.     It eliminates the inefficiencies that tend to result from meaningless competition.

4.     Private monopolies are controlled by the state. This helps to protect the consumers from being exploited in form of high prices charged by private monopolists.

5.     People’s welfare is improved since emphasis in production is on welfare and not commercial gains.

6.     It ensures that adequate resources are devoted to production of public and merit goods.

7.     The system can cope with rapid structural changes such as drought, famine, floods, earthquakes, etc through proper planning by the central planning authority.

8.      The system caters for the unprivileged groups of people in the society such as the lame and the poor hence equal distribution of opportunities.

9.     It controls the production of harmful products in the economy. The government is in position to regulate the production of such commodities like alcohol, cigarettes through taxation.

10. Some key areas like production of fire arms cannot be left in the hands of private individuals. This is because it may cause insecurity in the country hence a need for a planned economy.

11. More employment opportunities are provided as the government tries to improve welfare and even out income distribution.

DEMERITS OF THE COMMAND ECONOMY

1.     Many officials are required to estimate wants and to direct factors of production accordingly. This results into high costs.

2.     It is hard to accurately estimate peoples’ needs since there are many. This leads to wastage of resources due to poor judgement of wants and some needs may remain unsatisfied.

3.     Bureaucracy and red tape which are associated with the system lead to delay in production and planning. This makes development to move at a slow pace.

4.     There is inefficiency in production due to absence of stiff competition.

5.     The quality of final goods and services produced is low due to lack of competition.

6.     Limited variety of goods is produced as government’s interest is in provision of necessities of life. This limits the choice of consumers and they may be forced to consume goods which are not of their choice.

7.     The system is a disincentive to private or individual initiative due to state ownership of resources. I.e. what belongs to the state is no man’s resource.

8.     The system is associated with limited inventions and innovations due to absence of competition.

9.     The system is associated with high levels of corruption and embezzlement of government funds. This is because the sector cannot supervise all the sectors effectively.

10. It leads to imbalance in regional resource allocation and development. This is due to state influence in resource distribution basing on political support.

11. It leads to budgetary deficits in the economy. This is due to high administrative costs and subsidization of parastatals which are not economically productive.

12. It is difficult to coordinate all the economic activities at the same time. This is because the government has a lot of responsibilities.

ASSIGNMENT

Present the advantages of capitalism over socialism.

MIXED ECONOMY

Is one where resources are owned, allocated and distributed by both the state and the private individuals (market forces of demand and supply).

FEATURES OF A MIXED ECONOMY

ü Ownership of resources is both by the state and private individuals. Some productive resources like land and industries belong to the government while others are privately owned.

ü Economic decisions are made by both the state and private individuals.

ü Production is both for profit and welfare maximization. The state produces goods to improve peoples’ welfare while private individuals produce to maximize profits.

ü Resource allocation is by both the market forces of demand and supply and the central planning authority.

ü There is co-existence of both the private and public sector.

ü There is existence of indicative planning. Indicative planning is one where the government draws plan targets and provides (conducive) political, social and economic policies to guide the private sector but it does not participate in plan implementation.

ü Regulated competition in production and consumption. The government uses its authority to check on competition between firms.

MERITS OF A MIXED ECONOMY

1.     Limited resource wastage due to regulated competition.

2.     Better quality products are produced because of competition between the private and public sectors.

3.     Production of a wide variety of products by both the private and public sectors

4.     Reduced income inequalities due to state control.

5.     Individuals’ self interests are regulated e.g. over exploitation of resources and consumer exploitation.

6.     It increases employment opportunities due to existence of both the private and public sectors.

7.     The public sector provides essential goods and services that the private sector would not provide.

8.     There is economic stability due to government intervention.

9.     Increased rate of economic efficiency in production due to competition and planning.

10. The taxes got from the private sector can generate income for the government to fulfill its obligations.

DEMERITS

1.     In most cases, the private sector suffers from restrictions and taxes imposed by the state yet the public sector is subsidized thus the ground for competition is not leveled.

2.     Where the private sector is dominant, the consumers are exploited by the profit motivated producers. The producers can also influence government decisions politically and economically.

3.     An inefficient public sector is a big burden to the government since the government incurs losses, experiences corruption and nepotism. If the public sector is kept on going by the state through subsidies which increase its expenditures, it will lead to public debts and an increased debt burden.

THE ROLE OF GOVERNMENT IN A MIXED ECONOMY

NB:

In economics, we look at the role of……..from a functional perspective i.e. in this particular case, we focus on what the government does or what it puts in place in a mixed economic system. Hence the role (functional work) of government in a mixed economy is thus;

1.     Enacting and enforcing laws that govern trade or business activities. The government creates a set of laws for example the law of contract, consumer protection laws, Sale of goods Act, Food and drugs Act, etc. such laws help in regulating the way commercial activities are to be conducted in an economy.

2.     Supplementing and modifying the price mechanism. The government in a mixed economy may intervene in the working of price mechanism through measures like price controls, taxation and subsidization. For example, legislation of maximum price by the government helps in protecting consumers from being exploited by producers through over charging.

3.     It reduces or checks income inequality. The government uses policies like progressive taxation, supporting small and medium scale enterprises, diversification of the economy, etc to create a fair distribution of income among people in an economy. Fair distribution of income promotes savings and investment.

4.     Ensuring macro-economic stability. The government is in charge of fighting inflation by regulating the volume of money in circulation. It also ensures that the exchange rates are stable in order to promote international trade. Macro-economic stability is important because it promotes investment which gives rise to production of more goods and services.

5.     Providing essential goods and merit goods to the public at affordable prices. The government in a mixed economy provides merit goods such as safe water, health care (immunization programmes) and education usually at subsidized costs. E.g. The government of Uganda is currently providing universal primary and secondary education in government – aided schools.

6.     It checks social costs (negative externalities) in a country. The government uses environment protection laws to check or reduce the degradation or pollution of the environment. It ensures that there is proper treatment and disposal of industrial waste, garbage. By controlling the social costs, the government is able to improve the quality of life of the people.

7.     Ensuring that political stability prevails in an economy. By promoting political stability, there is assured security of life and property of people. This stimulates investment both in the public and private sector.

8.     It levies taxes to generate revenue to finance her development programmes or activities. The government is able to finance its capital and re-current expenditure by using the revenue generated from taxes levied on incomes of individuals, goods, profits of companies, etc.

9.     Undertaking strategic ventures which cannot be left in the hands of private investors. Such ventures include the manufacturing of ammunitions, printing of the national currency, etc.

10. Undertaking projects that require large initial capital which the private investors are unable to raise. Such projects include construction of hydro – electric power generating dams, construction of roads and rail lines, etc. By financing such projects, the government directly supports the activities of the private sector.

11. Influencing the location of industries in particular areas. This is achieved by gazetting land for industrial activities such that the areas become industrial estates. For example Namanve industrial estate which was gazetted by the government of Uganda.

12. Supporting up-coming investors by providing investment incentives such as tax holidays and subsidies. These investment incentives help investors to incur lower costs of production. This increases production by private investors in a mixed economy.

13. Formulating/ laying down plans to be followed by the private sector or private investors and the public sector. For example, the Plan for Modernization of Agriculture (PMA) which was designed by the government of Uganda requires participation of both the public and private sector in the economy for its effective implementation.

14. Providing and maintaining the physical infrastructure in an economy (roads, rail lines, power dams). Such infrastructure greatly supports the production  process leading to increased output in terms of goods and services. The production of more goods and services gives rise to economic growth.

15. Ensuring creation of more employment opportunities for its people. In a mixed economy, government sets up and runs public enterprises that operate alongside private enterprises. Private and public investment expands and more jobs are created. The employed people earn income to buy basic needs of life and this improves their standard of living.