Types of Economic Systems


An economic system defines the use of resources by the people and these resources include time talent and physical resources available. The economy is the knowledge of using these resources in effective manner to create useful products and services. Economics thus includes the study about land, labor, money, investments, income, expenditure and production. While measuring the economy, behavior of the individuals is important, however, this addresses the aggregate behavior of the industries as well as the businesses, governments and countries. As per the definition of Paul.A.Samuelson(1948) “ economy is the study of how the societies use scarce resources to produce valuable commodities and distribute them among different people”.  The structure where the resources are converted to goods and services in order to meet the unlimited needs is the economic system.

Types of economic Systems

Economic system is specific for each nation and the economies of nations come under four basic types of economic systems as defined by the economists

Traditional economy

The economic decisions in the traditional economic system are influenced by the values, culture and customs of the society and this system is the characteristic of under developed economies where the nation is governed by the culture and religion.

Command economy

The central authority, normally the government control the economy in the command economy and the government ultimately decides on the allocation of resources and sets the prices for goods and services. In this system the decisions are not driven by consumers and they do not have a wider freedom for choice.

Market economy

Individuals make decisions in the market economy and the interaction between the individuals and companies in the market is the determinant for the allocation of resources. The individuals decide for investment and the production of goods and services.

Mixed economy

The elements of market and the command economy are combined in the mixed economy and even though economic decisions are influenced by the individuals, the government has a role in the allocation and the distribution of resources,

The free market economy and the planned economy

The greatest issue of debate is the free market economy or the planned economy and whether state has to decide upon the individual to produce and consumer goods or services or the individuals should be allowed to take economic decisions by themselves.

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Free market mechanism is the sole economic mechanism that is in tune with the dignity of the individual and this mechanism enables an individual to create a variety of opportunities with his or her capacities. However, this freedom is subjected to the provision that this do not interferes with the freedom of the other individuals to do their economic activities. The ways and processes of production and distribution are privately owned and the ownership can take up many forms that include one man business, joint stock companies, family run enterprises, and multinational corporations, workers cooperative and self sufficient communities.

The free economy operates as per the voluntary exchanges of sellers and buyers who trade their personal property without any pressure from the government. The individuals receive the economic rewards in the form of salaries and profits based on the economic players that exchange their products and services and the market in the free economy spontaneously evolves.

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The market is the efficient in generating wealth and even though there is a negative intervention of the government in the western societies, the free market is responsible to create a steady growth in the living standards for the people. The problems associated with the economy are in a different dimension that was experienced earlier in the socialist countries.  The free market economy is the most capable mechanism that satisfies the material needs of the human beings and the basic purpose of producing goods and services is to consume them. The free economy is a process of invention and this is a result of experiences of the entrepreneurs who get the accurate information about the needs of the customers which ultimately benefits both the entrepreneur and the customer. The entrepreneurs are encouraged to innovate that enables them to reduce the price of the product in order to gain a competitive advantage from its competitor.

Market is necessary for the pluralistic democratic system of the government as there is decentralization of power due to private ownership.  Freedom in the market economy is safeguarded because of the existence of the alternative source of employment.

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Socialist planning economy tends to the complete subordination of the individual that restricts his or her freedom of action as the economy is controlled by the state. In a free market economy an existence of diversity associated with health care, education, employment opportunities along with the availability of goods and services.  In the socialist economy choice is eliminated by the policy makers and the economic and productive resources of the society are controlled by the government.  Government directs the production of goods and services, prices of goods, the investment of the capital and the wages of the people.

Planning is not compatible with the fundamental right of the individual and in a planned economy an individual cannot make decisions which are a disaster to the economy. Two important reasons can explain the inefficiency of the planned economy to satisfy an individual. The government cannot get the adequate information about the preferences of the people with regard to production and the distribution of resources that can meet the needs of the consumer. Price signaling mechanism is necessary to the changing needs of the people and this is possible in the market economy where the firms operating in the markets try to anticipate the demands of the customers.

In planned economies, the existence of one rigid plan poses a greater risk of failure of effort to meet the needs of customer and in an economic system the industries are highly protected by the government. Produces are little concerned about the needs of the customer as no other private supplies are allowed.  Resources in a planned economy are allocated as per the priorities of the politicians rather than consumers and these results in massive shortage of certain types of goods which are regarded as unnecessary luxuries.

Earlier governments regulated the economies and it was assumed that these interventionist policies may improve the economic growth. There was increased public spending, and taxation, imposition of import controls, imposition of price, wage controls, and provision of larger subsidies to major industries place more and more industries under the government control. However, this resulted in higher taxation and unemployment and this is the cause of economic problems of today.

Market economies do not provide magic solutions but the government plays a crucial role in correcting the problems that is not possible for the private marketers. In the global economies, the market economies has the pressure of public policies that include inflation, pollution, poverty, unemployment, and most important of all, the barriers to trade.  However, when compared to the chronic shortages and hidden inefficiencies of the planned economy, greater opportunities exist for economic growth, innovation, technological progress and prosperity.  

Economic freedom meets the needs of the individual but when it is guided by a force that dictates all the human activity as per a single plan then the liberties is conceded. The free market allows price competition that decreases the price of the product,


It is now evident that free market economy is a good economy that can keep the people happy and the free market economies work best. Planning economy highly interferes with the lives of the people by dictating them to buy the goods the government allows, and one advantage with the planned economy is its efficiency in managing. Economic freedom not only enables to pursue the economic interests but also enables the individuals to pursue their career of choice. The unique interests of the individuals are encouraged by the availability goods in the economically free market and the balance between the supply and demand regulates the economy.  Some of the aspects of the market economy such as competition, economic freedom and a balance in the supply and demand helps to maintain a healthy economy. The healthy economy creates a high standard of living and consequently the quality of life improves and this results in greater equality and prosperity.  The free market leads to complete efficiency that brings optimal distribution of the resources of the country and this is possible in a state of equilibrium between the demand and the supply. However, in order to make the economy efficient and to bring a welfare state the government has to play a role in controlling certain segments of the economy. The governments should thrive for a welfare state where there is free market economy under the centralized political control which is the most effective to bring a welfare state.

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