What is an economic system? Definition and meaning

An economic system is an organized way in which a country allocates resources and distributes goods and services across the whole nation or a given geographic area. It is includes the combination of several institutions, entities, agencies, decision-making processes and patterns of consumption that make up the economic structure of a specific community. Hence it is a type of social system.

An economic system defines how all the entities in an economy interact. Defining them today is much more complicated than it used to be. Ancient systems were relatively simple – trade was carried out using barter and there were very few treaties and rules of engagement.

Economic systemAn economic system defines how goods and services are produced, distributed and at what price. There are three main types: a market, mixed or planned economy.

Economic systems today are complex

In ancient societies, people only exchanged what they had for what they wanted or needed. Today, however, in monetary economies, the setting is much more sophisticated.

We currently live in a society where massive corporations have a strong influence on how business is done. Agreements and treaties are negotiated and signed every day, and governments have made many laws concerning trade, which means we require a much more comprehensive definition of what an economic system is.

One could say that today, therefore, an economic system is described as an organized manner in which a particular government has chosen to allocate its country’s goods and services.

Systems in today’s economies are about much more than simple trade. They define our society’s values and its political structure.

Vladimir Putin quote using term economic systemVladimir Putin, the President of the Russian Federation, once said: “It’s a historical phenomenon that in 250 years, a nation could move from a colony into the most prosperous nation of the world and the leader of the world. It is indeed an achievement, a tribute to the talent of the American nation, the American people and an optimal political and economic system.” (Image: twitter.com/PutinRF_Eng)

Every economic system looks at three or four basic questions:

– What to produce.

– How to produce and how much.

– Who receives production’s output.

– How change is going to be effected and accommodated.

The structure of each economic system seeks to answer these three or four questions. The system sets the rules of play for all the players in an economy, and defines how they can interact with one another.

The study of economic systems looks at how their various components are interlinked, how information flows between them, and their social relations, including the structure of management and property rights.

The analysis of economic systems used to focus on two extremes – planned and market economies, and on the differences between socialism and capitalism.

Today the classification of economic systems has expanded to include other models and topics that do not conform to those traditional extremes. Globally, the currently dominant form of economic organization is based on varying versions of a market-oriented mixed economy.

Three economic systemsThere are three main types of economic systems. Most countries across the world are market economies.

Three main economic systems

In this world there are three main types of economic systems. Governments and their leaders claim to have their own peculiar systems, but they are all basically mixed economies. Economic systems can be basically classed into three categories.

Market economy: here prices are determined by levels of supply and demand, instead of central and or local government. Market forces determine what is produced, how much is produced, how it is distributed, plus the prices of goods and services.

All decisions regarding investment and salaries are also driven by market forces in a market economy.

In a market economy, the government plays a minor role and only lays down the rules so that businesses can thrive. An outdated word for this type of economy is Capitalism.

Jacques Delors economic system quoteJacques Delors, a French economist and politician who was the 8th President of the European Commission (1985-1995), once said: “The European model is, first, a social and economic system founded on the role of the market, for no computer in the world can process information better than the market. Jacques Delors.” (Image: Wikipedia)

Planned economy: all decisions regarding production, distribution, salaries, investment and prices are made by a central authority – usually the government. The closest examples to this type of economy today are North Korea and Cuba (to a lesser extent).

In a planned economy, also known as a centralized economy, controlled economy or command economy, central government has planners who make all the decisions.

According to economists, the most fundamental difference between a market and planned economy is the existence of private property, i.e. it exists in the free market and does not in the command economy.

Mixed Economy: market economies sometimes get into trouble, at which point the government feels compelled to intervene. Sometimes, when lawmakers believe some players are being exploited unfairly, or the level playing field for business is under threat, the government may become involved.

Similarly, the leaders of a command economy may decide that more investment is required, and the only way to accomplish this is by allowing more freedom.

The moment the government of a command economy loosens its grip, or that of a market economy begins to intervene, they integrate some aspects of the other. When this occurs, the result is a kind of hybrid system – a mixed economy.

With the exception of North Korea, every country in the world has a mixed economy. Even Cuba has elements of a mixed economy – it has a huge black market which the government semi tolerates.

Small, ancient societies that depended on hunting and subsistence farming had Traditional Economies. Some small societies today still have this type of economy, such as a traditional Inuit village in North America or a tribe in the Amazon rainforest.

According to BusinessDictionary.com, a mixed economy is:

“An economic system in which both the private enterprise and a degree of state monopoly (usually in public services, defense, *infrastructure, and basic industries) coexist. All modern economies are mixed where the means of production are shared between the private and public sectors.”

* Infrastructure refers large structures and services without which our society as we know it could not function properly – including roads & railway networks, tunnels, bridges, sanitation, water, power generation and generation, etc.

Video – Types of Economic Systems

This UniversityNow explains what types of economic systems exist in the world, including the traditional economy.