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Comparative Economic Systems

Comparative Economic Systems

Author: Kate Eskra

This tutorial explains comparative economic systems.

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Hi. Welcome to economics. This is Kate. This tutorial is on comparative economic systems. As always, my key terms are in red and my examples are in green. In this tutorial, first, I'll list for you the three questions that every economy answers. We'll be talking about market and command economies, and I'll be comparing those. And finally, we'll talk about why most economies today in the world really aren't either pure market or pure command economies.

So we know that economics as a study looks at choices. We know the term "scarcity," and we know that things in the world are scarce. So because of that, consumers and firms have to make choices all the time. When consumers make choices, they're looking to maximize their utility. When firms make choices, they're looking to maximize profit. Every choice made every day involves an opportunity cost. When we take all of our choices and add them up together, that's going to equate to societal choices.

So it's economic systems that have developed in order to help our society answer three big questions, and those questions are first of all, what is it that should be produced? What goods and services are important to us and our country, and what do we want to see produced? Second, how should those things be produced? Once we decide what's going to be produced, how are we going to produce them, with what kind of technology, for example? Finally, once everything's all produced, how is it going to be allocated? Who should receive it?

Now, it's really going to depend on a society's values. Just as individuals have different values, so do societies. Depending on how the society as a whole ranks or prioritizes values, all of these questions could be answered very differently.

Let's start with a market economy. A market economy is one where the price of goods and services is completely determined according to supply and demand. In a pure market economy, there is absolutely no government interference at all. Sometimes you'll hear the term "laissez-faire" to describe a market economy, meaning hands off.

So the government would not intervene to provide any public goods at all. There would be no safety nets like social security or any of the welfare programs, for that matter. This would be a government that's completely relying on supply and demand in the private marketplace to figure out all of those three economic questions. Individuals and firms who would decide what gets produced, how it gets produced, and then who receive things.

If we look at the values that would rank high here, they would be first of all economic efficiency. We know that the marketplace without government intervention does a really nice job of efficiently figuring out what needs to get produced and what price is going to be the best price. You've seen equilibrium price and quantity time and time again, so it's a very efficient way of figuring out those things.

Economic freedom would also obviously rank high here. In a market economy with no government telling you what's going to be produced or controlling prices, or for that matter, as an extreme telling you what you have to do for a living, you are free completely in your economic life. And then finally, economic growth and innovation would be really encouraged in a market economy. There is that profit motive and profit motive alone driving things, and so people tend and businesses tend to do the absolute best they can because it's in their best interest to do so. So that encourages economies that are market based to have a lot of innovation and growth.

The opposite end of the spectrum here is a command economy. This is where goods and services are produced and sold according to government alone, instead of through the free market mechanism of supply and demand. In a pure command economy, there would be absolutely no private sector. Nobody would own anything themselves. Every good would be actually provided by the government. There would be no such thing as owning your own home or having any property of your own. Government would own everything. The government would answer what gets produced, how it gets produced, and then who gets it, or how is it allocated.

Obviously-- and I'll be talking about it a little bit in the next slide-- we know the shortcomings of command economies, communism, but certainly, we could look at some of the values that would rank high in this system, and those would be stability and predictability. So just able to kind of know exactly what is going to happen, that idea was, at least in theory, an idea behind communism or command economies. And then again, in theory, economic equity would rank high here, the idea that everyone should have the same amount of money, have the same amount of stuff. Not political equity but economic equity.

So we know that these economies have had problems throughout history, and part of that is because here, there is an absence of this profit motive. So whereas firms with a profit motive have the incentive to get people exactly what we want at a price we're willing to pay, we have in a market based economy an incentive to keep costs low as businesses and to constantly innovate and improve processes. But in a command economy, the government does not have that profit motive. They don't have these incentives, and so command economies lack efficiency and innovation.

In reality, most economies today in the world are mixed. They're neither really pure free markets or pure command. In terms of a pure free market with no government at all, there certainly are some countries that have less government than most. If you want to think about it in terms this way, you could think about Somalia until very recently, there was literally no government ruling anything or making any decisions, and it was really gangs controlling the country. I guess you could think of it that way, but it's very hard to find anything that's completely free of any government.

And also, pure command economies today are pretty rare. North Korea would probably be the closest to a pure command economy where the government is absolutely controlling everything. But we definitely have a spectrum of countries in the world today. Most of them, though, are very much mixed. It just depends on how much government is intervening.

Our country in the United States is certainly market based, where supply and demand is answering most of the questions and setting prices instead of the government, but government does intervene in our country to provide most public goods, to provide some protection for some of our common goods, to take care of that tragedy of the commons that can occur. And our government also intervenes to provide some safety nets like unemployment insurance if you lose your job or social security when you retire. Any of those welfare programs are actually provided by government, so we are not a pure market economy. Like I said, the level of government really does vary across country to country, but it also changes over time as conditions in the country change and as values in the society change.

In this tutorial, we talked about the three key economic questions that every economy answers of what's going to get produced, how it's going to get produced, and who gets it. We looked at the difference between market and command economies, and finally talked about why most economies today are mixed. Thanks so much for listening. Have a great day.

Notes on "Comparative Economic Systems"

Terms to Know

Market Economy

A system free to establish price of goods and services according to supply and demand

Command Economy

Goods and services are produced and sold according to government instead of through free market mechanism, supply and demand.