Types of Economic Systems (Cambridge (CIE) A Level Economics): Revision Note

An introduction to economic systems

• In order to solve the basic economic problem of scarcity, economic systems emerge or are created by different economic agents within the economy

  • These agents include consumers, producers, the government, and special interest groups (e.g. environmental or trade unions)

  • The economic system aims to allocate the scarce factors of production

• Any economic system needs to decide how to answer the three fundamental economic questions

  • What to produce? More weapons for the military, or more schools to educate the children?

  • Who to produce for? Only those who can afford to pay for it? Or for everyone in society?

  • How to produce it? Should more labour be used, or should the economy focus on using technology instead?

• An economy can be considered to be a free market, mixed or planned economy

  • The type of economy is determined by how the three economic questions are answered

  • This ultimately determines the amount of government intervention in an economy 

• North Korea is a planned economy

• The United States, Japan and Singapore are mixed economies but have less government intervention than Norway, Germany or China

Free-market economies

• A market economy is an economy that has no government intervention in the allocation of resources and distribution of goods or services

  • This is also called a free market economy

  • There is no purely free market economy in the world but some countries have less government intervention than others

Characteristics of a market system

The price mechanism plays a central role in resource allocation

• When firms produce more than consumers demand, a surplus occurs

• This surplus leads to falling prices, encouraging more purchases

• Lower prices may cause firms to reduce production

• As supply drops, prices begin to rise again

• Higher prices attract firms back into the market, increasing supply

• This cycle continues, helping balance supply and demand

• The government’s role is limited to monitoring the system and stepping in only when the market fails to allocate resources efficiently

Planned economies

• A planned economy is an economy in which all of the resources are owned by the state and the government controls the distribution of goods and services

  • Karl Marx believed that free markets lead to capitalism, in which the owners of the factors of production (Capitalists) exploited the workers

  • This creates inequality, which will lead to a breakdown between the classes

  • The role of the State is therefore to share the means of production and ownership with all of the workers in society

  • This required the abolition of private property

  • This required the State to become the central planner, deciding how each of the three economic questions would be answered

Characteristics of a planned economy

Decisions about the allocation of resources

• In such economies, choices about what goods and services to produce, how to produce them, and who receives them are made by central authorities

• Planning boards and government agencies oversee production, and consumer preferences are managed centrally rather than by market forces

• Governments in planned economies often pursue rapid development to match the progress of more advanced market economies

• Today, few countries operate under this model, with Cuba and North Korea being notable examples

  • Socialist-leaning nations like Albania and Vietnam share some features but are not fully planned economies

Mixed economies

• A mixed economic system is a blend of a market and planned economy

  • Individuals, firms and the government own factors of production and distribute goods or services

  • In reality, almost every country in the world operates as a mixed economic system

  • Some countries have more government intervention than others

    • e.g. China has more intervention than the USA

  • The higher the level of government intervention, the more the economy will lean towards operating like a planned economy

Decisions about the allocation of resources

• A mixed economy combines elements of both private enterprise and government involvement in managing resources

• Decisions about production and distribution are shaped by interactions among businesses, workers, and the state, with the market mechanism playing a central role

Examples

• Over the past few decades, many countries, especially those in Central and Eastern Europe have shifted toward privatisation

  • This transition has significantly impacted industries such as manufacturing, particularly in the UK and similar regions

• The restructuring of the Soviet Union’s economy, known as perestroika, marked a major shift toward market-oriented reforms

• Countries known as the Asian Tigers including Singapore, Malaysia, the Philippines, Indonesia, and China have pursued rapid economic development by combining state planning with market-driven strategies

Evaluating mixed economies