Economic Systems: Market vs. Central Planning
Economic Systems and Basic Needs
An economic system is the way individuals in a society are organized to solve their basic economic problems. Every economic system must answer three basic economic questions: what to produce, how to produce, and for whom to produce.
What to Produce
This involves determining which goods and services will be produced and in what quantity. Are we going to produce many goods? Is it better to produce a large quantity of lower quality, or a smaller quantity of higher quality?
How to Produce
The next problem is how to produce the goods. This includes determining the techniques, the energy source to be used, and whether production will be craft-based, etc.
For Whom to Produce
We must decide who the target consumers will be and how the goods will be distributed.
To solve these problems, there are two primary economic systems: the market economy and the central planning system.
Economic Doctrines and Economic Systems
Economic doctrines have influenced events, changes, and revolutions. An economic doctrine is a set of ideas or opinions from a group of leading economists. There are two major economic doctrines: liberalism and Marxism.
- Liberalism: Gives primacy to the functioning of a market. When an individual serves their own interest, they also contribute to the welfare of the community. Liberalism rests on the functioning of the market economy.
- Marxism: The opposite of economic liberalism. Marxism relies on central planning and the empowerment of the state.
Market Economies
The operation of this economy is based on a set of markets where the buying and selling of goods and services, as well as inputs, takes place. This answers the three questions posed by any economic system: what to produce, how to produce, and for whom to produce. A market is any social institution in which goods and services, as well as factors of production, are freely exchanged.
Operation of a Market Economy
Companies sell their production in exchange for money, and money is exchanged for work. In any market where money is used, there are two types of agents: buyers and sellers. It is essential in any market that buyers and sellers of goods or services freely come into contact. When this occurs, we say that there is a marketplace.
Markets and Prices
In markets, sales are made easily. Buyers and sellers agree on the price of goods, so that the exchange of goods for money will occur. The price of a good is its relationship to money exchange; that is, the amount of money needed in exchange for one unit of the good. When setting prices for goods and services, the viability of a capitalist market system is ensured.
The Invisible Hand
The market mechanism does not require direct contact between consumers and producers. The relationship is indirect and occurs through prices and markets. If consumers want something and have the money, they buy it. If many people do the same, the total sales of that product will increase, and so will its price. Producers, seeing that sales and prices are increasing, increase the production of those goods and employ more resources. There need not be direct communication between consumers and producers: sales and prices convey the message and direct the market, as if by an invisible hand.
Limitations of the Market Economy
- Income is not distributed equitably: Income is distributed according to how the ownership of resources is distributed and the prevailing wages. There are often enormous income differences.
- There are market failures: The market sometimes fails in its attempt to achieve economic efficiency. The system fails when there are markets where competition is not perfect, when there are externalities, and when there are public goods or common property resources. It also fails when the economy suffers crises and when the distribution of income is not very egalitarian.
- Advertising can be used to manipulate consumers: Companies can use advertising to manipulate the desires of consumers and create artificial needs.
- Market economies tend to be unstable: The market is in the hands of private initiative and is usually unstable, suffering strong crises.
The Operation of a Centralized Economy
This system is in force in places like Cuba.