Economic System - Overview, Types, and Examples

An economic system is a means by which societies or governments organize and distribute available resources, services, and goods across a geographic region or country. Economic systems regulate the factors of production, including land, capital, labor Labor Market The labor market is the place where the supply and the demand for jobs meet, with the workers or labor providing the services that employers demand. The worker may be anyone who wishes to offer his services for compensation while the employer may be a single entity or an organization , and physical resources. An economic system encompasses many institutions, agencies, entities, decision-making processes, and patterns of consumption that comprise the economic structure of a given community .

Economic System

Types of Economic Systems

There are many types of economies around the world. Each has its own distinguishing characteristics, although they all share some basic features. Each economy functions based on a unique set of conditions and assumptions. Economic systems can be categorized into four main types: traditional economies, command economies, mixed economies, and market economies.

1. Traditional economic system

The traditional economic system is based on goods, services, and work, all of which follow certain established trends. It relies a lot on people, and there is very little division of labor or specialization. In essence, the traditional economy is very basic and the most ancient of the four types.

Some parts of the world still function with a traditional economic system. It is commonly found in rural settings in second- and third-world nations, where economic activities are predominantly farming or other traditional income-generating activities.

There are usually very few resources to share in communities with traditional economic systems. Either few resources occur naturally in the region or access to them is restricted in some way. Thus, the traditional system, unlike the other three, lacks the potential to generate a surplus Consumer Surplus Consumer surplus, also known as buyer’s surplus, is the economic measure of a customer’s benefit. A surplus occurs when the consumer’s willingness to pay for a product is greater than its market price. . Nevertheless, precisely because of its primitive nature, the traditional economic system is highly sustainable. In addition, due to its small output, there is very little wastage compared to the other three systems.

2. Command economic system

In a command system, there is a dominant, centralized authority – usually the government – that controls a significant portion of the economic structure. Also known as a planned system, the command economic system is common in communist societies since production decisions are the preserve of the government.

If an economy enjoys access to many resources, chances are that it may lean towards a command economic structure. In such a case, the government comes in and exercises control over the resources. Ideally, centralized control covers valuable resources such as gold or oil. The people regulate other less important sectors of the economy, such as agriculture.

In theory, the command system works very well as long as the central authority exercises control with the general population’s best interests in mind. However, that rarely seems to be the case. Command economies are rigid compared to other systems. They react slowly to change because power is centralized. That makes them vulnerable to economic crises or emergencies, as they cannot quickly adjust to changed conditions.

3. Market economic system

Market economic systems are based on the concept of free markets. In other words, there is very little government interference. The government exercises little control over resources, and it does not interfere with important segments of the economy. Instead, regulation comes from the people and the relationship between supply and demand Supply and Demand The laws of supply and demand are microeconomic concepts that state that in efficient markets, the quantity supplied of a good and quantity demanded of that good are equal to each other. The price of that good is also determined by the point at which supply and demand are equal to each other. .

The market economic system is mostly theoretical. That is to say, a pure market system doesn’t really exist. Why? Well, all economic systems are subject to some kind of interference from a central authority. For instance, most governments enact laws that regulate fair trade and monopolies Natural Monopoly A natural monopoly is a market where a single seller can provide the output because of its size. A natural monopolist can produce the entire output for the market at a cost lower than what it would be if there were multiple firms operating in the market. A natural monopoly occurs when a firm enjoys extensive economies of scale in its production process. .

From a theoretical point of view, a market economy facilitates substantial growth. Arguably, growth is highest under a market economic system.

A market economy’s greatest downside is that it allows private entities to amass a lot of economic power, particularly those who own resources of great value. The distribution of resources is not equitable because those who succeed economically control most of them.

4. Mixed system

Mixed systems combine the characteristics of the market and command economic systems. For this reason, mixed systems are also known as dual systems. Sometimes the term is used to describe a market system under strict regulatory control.

Many countries in the West follow a mixed system. Most industries are private, while the rest, comprised primarily of public services, are under the control of the government.

Mixed systems are the norm globally. Supposedly, a mixed system combines the best features of market and command systems. However, practically speaking, mixed economies face the challenge of finding the right balance between free markets and government control. Governments tend to exert much more control than is necessary.

Final Word

Economic systems are grouped into traditional, command, market, and mixed systems. Traditional systems focus on the basics of goods, services, and work, and they are influenced by traditions and beliefs. A centralized authority influences command systems, while a market system is under the control of forces of demand and supply. Lastly, mixed economies are a combination of command and market systems.

More Resources

Finance is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ FMVA® Certification Join 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional Finance resources below:

  • Autarky Autarky Autarky is the term used to describe a country or economy that operates independently. Autarky, in its most basic sense, means "self-sufficient," though it’s almost always used in correlation with a political or economic system,
  • Real Economy Real Economy The real economy refers to all real or non-financial elements of an economy. An economy can be solely described using just real variables. A barter economy is an example of an economy with no financial elements. All goods and services are purely represented in real terms.
  • Socialism vs. Capitalism Socialism vs. Capitalism In an economy, socialism vs. capitalism represent opposing schools of thought, and their central arguments touch on the role of government in the economy and economic equality among the citizens
  • Tragedy of the Commons Tragedy of the Commons The tragedy of the commons is an economic theory that states that individuals use up resources shared by many to benefit themselves. The reality is often that because individuals tend to act in a selfish way, using resources shared by a group, everyone ends up suffering in the end.