2. Who Decides What in Different Economic Systems?
In the process of answering the three economic questions, every society develops an economic system. An economic system is the way a society coordinates the production and consumption of goods and services. Economic systems are as old as humankind, so you might expect there to be many different models. But if we strip away all the cultural differences that exist between all the societies that ever were, we find that history has produced only three basic types of economic systems. There are those built on tradition, those based on the command of rulers, and those organized by free markets. Each system answers the three economic questions differently. And each emphasizes different economic goals.
Traditional Economies: Decision Making by Custom
The first and oldest economic system is the traditional economy. Traditional economies have existed since the first clans of hunter-gatherers emerged in Africa. In a traditional economy, custom and tradition dictate what to produce, how to produce it, and for whom.
Most traditional economies that survive today belong to indigenous people who live much as their ancestors did hundreds or thousands of years ago. The Maasai of East Africa, for example, are a seminomadic herding people. Livestock, primarily cattle, is an important part of their economy and Maasai wealth is measured in cattle and children. The traditional Maasai diet consists primarily of meat, blood, and milk from cattle. The Maasai's answer to the question of what to produce is cattle, because it is their centuries-old tradition to raise cattle.
As for the question of how to produce, people in traditional economies engage in farming, herding, fishing, hunting, and the gathering of wild plants. Exactly who does what is determined by social customs. Labor is often divided along gender lines. Among the Maasai, for example, men build enclosures to protect the cattle from lions, boys graze the cattle, and women and girls milk the cattle. Among the Khoi-San people of the Kalahari Desert in Southern Africa, men hunt and women gather.
For whom to produce is another question decided by tradition. Social hierarchies play an important role. A good illustration of this is the way meat is distributed among the Khoi-San people of the Kalahari. After a hunt, the kill is divided up, with a large share going to the hunter. He gives some to relatives, and they give part of theirs to other relatives, all according to the accepted social order. In the end, everyone gets enough to eat.
The highest goals of people in a traditional economy are economic stability and security. Most want nothing more than to live as they always have, following traditional ways of life, in harmony with nature. For most traditional societies, though, this goal is increasingly difficult to attain. Traditional economies have continued to shrink as they come in to more contact with the modern world. As modern economies exert an ever-growing influence, traditional societies are struggling to find a path to economic survival.
Command Economies: Decision Making by Powerful Rulers
The next economic system to develop is what economists call a command economy. In a command economy, decisions about what, how, and for whom to produce are made by a powerful ruler or some other authority.
The earliest command economies originated in Mesopotamia, Egypt, China, and India about 5,000 years ago. As these civilizations became highly advanced, centralized governments arose that were headed by powerful rulers. These rulers imposed their economic choices on society. This happened even as tradition still guided economic activity at the lower levels of society.
Rulers at the top of these early civilizations—kings, pharaohs, emperors—commanded the populace to devote economic resources to building projects or military adventures. Many thousands of people might be conscripted to build a pyramid, defensive wall, irrigation canal, temple, or road. In a preindustrial age, such projects took vast quantities of human labor. Often, many people would be drafted into a ruler's army and sent into battle in distant lands.
The primary goal of these ancient command economies was to accumulate wealth and goods for the ruling class. It also needed to preserve economic stability. The many monuments these societies are a testament to this economic system. It shows both their productive power and the excesses of their rulers.
Market Economies: Decision Making by Individuals
The newest economic system to emerge in human history is the market economy. A market economy depends not on tradition or command to coordinate its activities but on the decisions of individual producers and consumers. Note that when economists speak of “the market,” they are referring to the economic system within which buyers and sellers exchange goods and services. This is distinct from an everyday market, which is a place where people buy and sell goods.
In a free market economy, the workings of the market are not planned or directed. No one—no single person, business, or government agency—tells producers or consumers what to do. Economic decisions are made voluntarily, one at a time, by millions of individuals guided by self-interest.
The highest goals of a market economy are economic freedom and efficiency. Individuals and businesses are left at liberty to decide what, how, and for whom to produce. The producers of goods and services make these decisions based largely on consumers' spending decisions. Because you are free to buy what you want, producers must compete for your dollars. This competition means that you, the consumer, have many choices. It also forces producers to use resources efficiently. If they do not, a competitor will find a way to offer the same good or service at a price that consumers will be more willing to pay.
In a free market, individuals are encouraged to pursue the jobs that allow them to make the most of their human capital. If one employer fails to pay them what they think they are worth, they can quit and seek employment elsewhere. Or they can start their own businesses, perhaps even offering new products or services to consumers.
You might expect this individual decision making and competition would be chaos. But just the opposite is true. Markets are highly efficient at producing a great variety of goods and services that people find attractive and at prices they are willing to pay. It was this coordinating power of markets that Adam Smith famously described as “the invisible hand.” He wrote,
Every individual . . . neither intends to promote the public interest, nor knows how much he is promoting it . . . He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention . . . By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.
—Adam Smith, The Wealth of Nations, 1776
diagram
The Flow of Money and Goods in a Market Economy
The reason markets work so well is that one person's output always becomes another person's input. Goods are produced and consumed. Money comes in and goes out. This flow keeps the economy running. Economists use the circular flow model to illustrate these interactions.
In the simplified market economy, there are two kinds of participants: households and firms. A household is made up of a person or of a group of people living together. The model assumes that households own the factors of production. A firm is an organization that uses these factors to make and sell goods or services.
The model also includes two kinds of markets. One is the product market, in which goods and services are sold by firms and purchased by households. Your local mall or supermarket is part of the product market. The other is the factor market, in which households sell their land, labor, and capital to firms. A household, for example, might rent land to a firm. Or members of a household might sell their labor to a firm for wages. They might loan money to a firm in exchange for interest payments, or they might buy a firm's stock in the hopes of receiving dividend payments. The funds paid to households—whether in the form of rent, wages, interest, or dividends—are known as factor payments.
This model is circular. Households buy products from firms with money that they receive in the factor market. Firms acquire land, labor, and capital from households using money that they receive in the product market. For example, you (as part of a household) might buy a pair of jeans from a firm with money that you earned by working at a local ice cream parlor (another firm). The ice cream parlor, in turn, pays you for your labor with money that it receives from selling ice cream cones to other households.
All these transactions are conducted by people and businesses who want something for themselves. People work so that they can buy things. Firms employ people so that they can make things to sell. In a market economy, everybody chooses what is best for him or herself. As Adam Smith observed, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
Capitalism Gives Rise to Socialism and Communism
Market economies emerged in Europe in the 1700s and began to grow rapidly in the 1800s. This economic growth was a direct result of the Industrial Revolution. During the Industrial Revolution, new inventions and manufacturing processes spurred the growth of industry. Individual investors, called capitalists, grew wealthy by accumulating capital, such as machinery, factories, and railroads. The term capitalism came to be synonymous with the free market economic system.
The headlong growth of capitalism had profound effects on society. As more and better goods became widely available, people's standard of living improved. But capitalism did not improve the quality of life for everybody. The workers who filled the factories and mills labored under harsh conditions. Most worked extremely long hours for meager wages. Critics of capitalism blamed the capitalists for exploiting workers and keeping them in poverty.
In 1848, economist Karl Marx and philosopher Friedrich Engels published The Communist Manifesto. In it, they advocated the overthrow of capitalism. They proposed an alternative vision of society known as socialism. Socialism is a political and economic philosophy that calls for property to be owned by society as a whole, rather than by individuals, for the equal benefit of all.
Marx and Engels argued that in a socialist society, the means of production—such as land, factories, and resources—would be owned and controlled by the workers themselves. They believed that this would eliminate the exploitation of labor by capitalists and create a more equal distribution of wealth and resources.
While socialism advocates for public ownership of the means of production, communism takes this idea further. Communism is a political and economic system in which all property is publicly owned and each person works and is paid according to their abilities and needs. In a communist society, there is no private property, and resources are distributed based on the principle of "from each according to his ability, to each according to his needs."
The ideas of socialism and communism gained popularity in the 20th century, particularly in response to the inequalities and abuses of unfettered capitalism. Many countries, such as the Soviet Union, China, Cuba, and Vietnam, implemented communist or socialist regimes. However, the practical application of these ideas has often led to authoritarian governments, economic inefficiency, and human rights abuses.
In contrast to socialism and communism, capitalism is based on the principles of private property, competition, and individual choice. In a capitalist system, the means of production are owned and operated by private individuals or companies. Prices, production, and distribution of goods and services are determined by market forces such as supply and demand.
Each economic system—traditional, command, market, socialism, communism, and capitalism—reflects different values, priorities, and beliefs about the best way to organize society. The choice of economic system has profound effects on people's lives, shaping their opportunities, freedoms, and overall quality of life. Ultimately, the question of who decides what in different economic systems is a complex and ongoing debate that continues to shape the world we live in today.
Activity: (fill this section)
Reading: The state, or government, decides what, how, and for whom to produce.
Activity: Production rewards were equal, based on predetermines quotas or goals
Reading: (fill this section)
Activity: (fill this section)
Reading: Factors of production are controlled by the government, which can not possibly foresee all market needs. Shortages are common.
Activity: All products sold for the same price.
Reading: (fill this section)
Activity: ( fill this section)
Reading: No incentive to produce high-quality goods or to innovate. Goods are often poor quality or not what consumers want or need.
This is based on the command group.
Activity: Citizens in a command economy may receive equal pay for their work, regardless of their job or skill level.
Reading: Production in a command economy is often focused on meeting government-set quotas or goals, rather than responding to market demand. This can lead to inefficiencies and surpluses of goods that consumers may not want or need.
Activity: In a command economy, the government may allocate resources based on political priorities or considerations, rather than economic efficiency.
Reading: In a command economy, all products may be sold at the same price determined by the government, regardless of production costs or consumer demand. This can lead to misallocation of resources and distortions in pricing.
Activity: Workers in a command economy may lack motivation to work hard or innovate, as their income is not tied to their performance or productivity.
Reading: In a command economy, the lack of competition and profit incentives can result in a lack of product variety, low quality goods, and little innovation. This can lead to stagnation and inefficiency in the economy.
This has to be based on making braces
Activity: Workers in a command economy who manufacture braces may receive equal pay for their work, regardless of their role in the production process or their level of skill.
Reading: In a command economy, the production of braces may be focused on meeting government-set quotas or goals, rather than responding to the actual demand for braces in the market. This could result in inefficiencies and a surplus of braces that may not be needed.
Activity: In a command economy, the government may allocate resources for brace production based on political priorities or considerations, rather than based on the actual needs of consumers.
Reading: In a command economy, all braces may be sold at the same price set by the government, regardless of the production costs involved or the quality of the braces. This fixed pricing system can lead to misallocation of resources and distortions in the market.
Activity: Workers manufacturing braces in a command economy may lack the motivation to produce high-quality braces or to innovate in their production process, as their income is not tied to their performance or productivity.
Reading: In a command economy, the lack of competition and profit incentives can result in braces of low quality or that may not meet the needs or preferences of consumers. This can lead to a lack of variety and innovation in the brace market, ultimately harming consumers.