Why Do Economic Systems Exist?
Scarcity
The idea that available resources (land, labour, capital, entrepreneurship) are limited and unable to satisfy unlimited human needs and wants.
Economic System
A way a society organizes production and distributes resources, deciding what to produce, how to produce it, and who receives it.
- Every society must answer three connected questions:
- What to produce (which goods and services)?
- How to produce (which methods, technology, and organization)?
- For whom to produce (who receives the output, and on what basis)?
- These questions matter because scarcity (limited resources) forces trade-offs.
- So, even if a society has "a lot" of a resource, it is never unlimited.
What Are The Two Broad Ways to Run an Economy?
Many real economies are mixed, but a core distinction is how decisions are made.
Command Economy
An economic system where key production and allocation decisions are mainly made by the government through planning and direction.
Market Economy
An economic system where production and allocation decisions are mainly determined by markets and the price mechanism.
- Think of a command economy like a school play where the director assigns every role and gives every instruction.
- A market economy is more like a talent show: people choose what to perform, the audience response (demand) influences what becomes popular, and performers adjust.
What Are Command Economies?
Three key components are slavery, feudalism, and fommunism
Slavery: production through coercion
Slavery
A system in which people are treated as property or are deprived of freedom and compelled to work through violence or coercion.
- In slavery, individuals are deprived of freedom and forced to work by someone who has power granted (or tolerated) by society.
- Slavery has been used to achieve economic and political goals, including domestic service, crop production, and large construction projects.
Feudalism: land, hereditary titles, and serfdom
Feudalism
A system where land was exchanged for loyalty and military service.
- Feudalism developed prominently in Medieval Europe (and also existed in places such as Russia and Japan).
- The economy was organized around land ownership and hereditary rule:
- A monarch and nobles (lords) controlled most land.
- Production was mainly agricultural, with some manufacturing (tools, weapons, textiles, carpentry).
- Most people were peasants or serfs with few rights.
- Serfs were typically tied to the land.
- They were not exactly property in the way enslaved people were, but they lacked freedom to move to better opportunities.
- With limited rights and education, many had little choice but to work the land and produce for the landowner.
- A key difference between slavery and serfdom is that serfs are "bound to the land" rather than owned as individuals, but both systems heavily restrict freedom and economic choice.
Communism and central planning: a modern command model
Central Planning
A method of organizing an economy in which a central authority sets production goals and coordinates the allocation of resources.
- The most recent major system to develop that involved central planning was communism.
- In the nineteenth century, Karl Marx and Friedrich Engels argued that capitalism in rapidly industrializing cities led to worsening conditions for many workers and to rising inequality.
- In their original view, a capitalism would contain forces that undermine it.
- Like competition pushing prices down and businesses trying to cut costs, including workers' wages.
- In their original view, a socialist revolution would move control of production to workers and, over time, the state would "wither away" as people made decisions communally.
- In practice, twentieth-century revolutions that claimed to be socialist or communist did not reach this stage, and decisions about production typically remained centrally planned.
What Are Market Economies and Capitalism?
Market
Any arrangement that connects buyers and sellers, enabling them to carry out an exchange.
Capitalism
An economic system in which individuals or firms own capital and employ labour to produce goods and services for sale, with investment and profit playing central roles.
- Over time, especially from the Renaissance onward in much of Europe, a growing middle class of merchants, traders, and skilled manufacturers emerged.
- Many were no longer tied to land like peasants, so they moved to cities and worked in manufacturing and trade.
- Political changes (including revolutions challenging monarchies) were closely connected to demands for greater freedom to own property and shape economic futures.
- In capitalism, ownership is mainly of capital rather than land.
- Capitalists (owners of capital) invest in businesses and employ workers to transform raw materials into goods and services that can be sold.
- A famous argument associated with market capitalism is that people's self-interest can help coordinate economic life.
- For example, producers supply goods because they benefit from selling them, not necessarily because they feel personally responsible for each buyer's wellbeing.
- When evaluating capitalism, separate two questions:
- (1) how markets coordinate decisions (through prices and incentives)
- (2) how outcomes are distributed (income, wealth, opportunity).
- A society can use market coordination but still choose policies that change distribution.
Why Are Most Real Economies Are Mixed?
- In practice, few countries are purely command or purely market.
- Most are mixed economies, combining market decision-making (prices, competition, consumer choice) with government roles (laws, taxation, public services, regulation, and sometimes state-owned industries).
- A useful way to compare countries is to ask:
- How much does the government own (land, firms, resources)?
- How much does the government plan (production targets, prices, wages)?
- How much freedom do individuals have to start businesses, choose jobs, and buy and sell?
- What three basic economic questions must every society answer, and why do they exist?
- What is scarcity, and how does scarcity create trade-offs even when a society has “a lot” of a resource?
- What are the three command-economy models described (slavery, feudalism, communism/central planning), and what is the key feature of each?
- What makes an economy “mixed,” and what three comparison questions can you ask to judge how market-based or government-led a country is?