Economic Systems


Economic System Definition

An economic system is an arrangement which determines the means for production, distribution, and trade of goods other than the consumption of the goods and services within the different units. These are generally classified on the basis of means of ownership. Economic systems consist of institutions and processes through which the society resolves the basic problem of resource allocation. The primary distinction between the different systems is the degree with which the government participates in the economy.

It is an evolving pattern of complex human relations which is concerned with the disposal of scarce resources for the purchase of goods and services which satisfies the needs of the people. It consists of those institutions which the people or nation have selected as the means though which the resources will be utilized and fulfill human wants.

Many types of economic systems have evolved through the years and there were some radical changes due to which the free market economy is now practiced or established. Economic institu¬tions form the building blocks of economic systems.

In the pre-history era, humans began with a complex system of community that included elements of labor, reward and trade. This led to domestication of plants and livestock, furthering the scope of tradable goods as well as tying people to the land so economies could develop. Many economic systems were attempted but the rule of powerful elite was most successful. There are four types of economic systems traditional, command, market and mixed economic systems based on the system of economic planning.

Traditional Economic Systems: Slavery and Feudalism


Slavery as an economic system influenced the economy by giving slave sellers more money since the need for slaves increased greatly. These sellers took advantage and acquired money and also people who bought slaves earned money. As more inventions were made, more slaves were needed. Slavery affected the social and class systems everywhere by helping many people become high-class citizens. The work slaves did help people get rich since the slaves were forced to work for free, which was acceptable for the slave owners because they were getting rich quickly without using money to pay workers. This helped slave owners gain more money than they needed to use.

Irrespective of the jobs, overall slavery was profitable. The expense to planters for housing, clothing, and feeding slaves was considerably less than the value they produced but expenses associated with the maintenance of one field hand were possibly half the value of the revenue the master expected from the slave's labor. Thus, in 19th century, profitability increased steadily as prices for cash crops rose and the cost of keeping slaves remained level. The slaves themselves became a good investment.

The controlled labor has been linked, directly or indirectly, to the upsurge of European industrialization, capitalism, the scientific revolution, rapid population growth, huge migrations, and changing social roles for men, women, and children etc.


It is an economic system where rights were closely related to the systems of land holdings. It an economic system of Europe, based on the holding of all land for fee. Feudalism discouraged unified government. It also oppressed trade and economic growth. Until the 12th century, less than 5% of the population of Europe lived in towns because skilled workers lived in the city but received their allowance from feudal lords rather than a real wage and the farmers were essentially serfs for landed nobles.

Due to the Black Plague which was one of the most devastating pandemics in human history shook up the system significantly by killing thousands of people in both town and countryside and the various other plagues of the dark ages actually created a labor shortage. The initiation of true wages offered by the trades encouraged more people to move into towns where they could get money rather than subsistence in exchange for labor and due to this, birth rates were high as ever and child labor and slavery was part of the lives of people and supported in economic development.

Mercantilism, Primitive Accumulation and Industrial Revolution

Mercantilism was the primary economic system of trade dominated during the 16th to 18th century. The goal was to increase a nation's wealth by imposing government regulation that took care of all the nation's commercial interests. This system believed that national strength can be achieved by limiting imports via tariffs and maximizing exports. It was heavily based on idea of protectionism and supported the idea of acquiring captive markets.

As technology advanced and the factories no longer had to be built near waterways to function, industrialists began building in the cities where there was supply of labor. Industrialists were the first people to accumulate their wealth in their lifetimes, outstripping both the landed nobles and many of the money lending/banking families. Now, the common people had hopes of becoming wealthy without being born into it.

The Industrial Revolution was a period of major industrialization during the late 1700s and early 1800s. The Industrial Revolution started in Great Britain but quickly reached the world and soon after the American Industrial Revolution, also known as the second Industrial Revolution, started sometime between 1820 and 1870. Northern victory in the U.S. Civil War (1861-1865) changed the destiny of the nation and its economic system. The slave-labor system was abolished. Industrialists dominated many aspects of the nation's life, including social and political affairs.

This period witnessed the technological advancement and automation in agriculture and manufacturing sector. There was revolution in power like steam ships and railroads that affected social, cultural and economic conditions. The Industrial Revolution changed the lifestyle of people and there were developments in nutrition, health care and education.

Capitalism and the Market Economy

Capitalism is an economic system where capital goods are owned by private individuals or businesses i.e. private ownership of means of production. The supply and demand of goods and services are determined by the market forces, this is generally called as a free market system where individuals invest, produce, sell etc. at their choice without any barriers. This type of system is unregulated or less regulated by the state.

Here, the capital is privately owned and distributed and mainly, the distribution mechanism is done by the market and it allocates the resources with the emphasis being on efficient allocation of capital. According to the “Invisible Hand” of Adam Smith that guides the allocation of resources, it is believed that the market does a good job of determining which sectors should receive the capital and in what amount. The role of government was gradually decreased until Smith described its duties as the provision of national defense, law & order and maintenance of public works. The accumulation of capital was considered as the driving engine of the system and thus, the expansion of capital as suggested by Smith determined the power by which the market system was launched on its historic course. According to Smith, the competition that depicts capitalism should work on its own i.e. free of government intervention. Therefore, capitalism is often referred to as laissez-faire capitalism and free-enterprise economy.

Commercial capitalism was considered as transitional in nature. The succeeding form was distinguished by the persistent mechanization and industrialization of the productive processes and changes introduced to new dynamic trends into the economic system which transformed the social and physical environment.

In theory, a market economic system allows an economy to experience a high amount of growth and the private sector is extremely powerful here. Thus, the distribution of wealth may not be beneficial for the society as a whole. Market economies are based on consumers and their buying decisions and these systems rely on the supply demand for pricing and do not utilize price controls or subsidies and prefer less regulation of industry and production. The profit motive is the driving force behind the whole economy and this accelerates the production process. There is no asymmetric information here, information regarding available products and services are available to producers and consumers.

Market economies work through the relationship of consumers and producers who are engaged in their own self-interest. The exploration of their self-interest is at the heart of free market economics. The consumers are free to take their decisions and reveal their preferences because the competition for their funds will require businesses to satisfy their needs and this consumer sovereignty helps in efficient allocation of resources. The aim of the government in this type of economy is to endorse free markets, keep inflation low and steady, and look after the rights of private property.

Centrally Planned Economic Systems and Command Economies


Karl Marx who is known as the father of communism was infuriated by the growing gap between rich and poor. He viewed capitalism as an obsolete economic system that exploited workers and due to this the poor gets unfair treatment. Marx thought that communism would replace capitalism in due of time. Communism is based on the principle that no private ownership of property should be allowed. Marx believed that private ownership promoted greed and caused people to move out of the competition. He believed that people should control the economy and the government should exercise control. The main purpose of communism is to eliminate the gap between poor and rich and establish economic equality.

In communism, the means of production are controlled and managed by the state. Marx visualized a classless society without personal property and hierarchy and people produce goods and services through the contribution of everyone and satisfy the needs too. Here, the workers are paid uniform wages and Marx called the “participation of the workers in the collective bargaining” is a feature of the system.

Thus, a community-centered structure which maintains social order is known as communism. China, Cuba is tried to move towards communism. Communism has not yet been proved as a practical concept.

With the understanding that people have of a communist society have ended up building state-driven authoritarian economies and government where a single party political elite takes the advantage and they are not accountable to the public. People do not have their own choices and everything is decided by the State. However, in such a system there will be rapid development and economic growth. Also, there will be equitable distribution of wealth. Communism is an extreme form of socialism. This type of system is also called as planned-economic system. Here, the government regulates the resources and most means related to the production. There is no relationship of the market forces of demand and supply and the pricing mechanism in deciding this allocation.

Another major feature of communist economies was their importance on the country's self-reliance which further discourages international trade and investment. The typical failed example of a command economy was the communist Soviet Union i.e. the fall down of the communist bloc in the late 1980s led to the end of many command economies around the world but Cuba still continues to hold on to its planned economy. Even though the idea of communism was to fulfill the needs of the masses, communist governments became oppressive system that manipulated their people to satisfy their own power.


In the classic view of communism, a communist society was the ultimate motive and destination for humankind. However, it is impossible to switch to a communist society from a capitalist society, thus, society needs time to adjust for the change and here, comes into picture- Socialism. During the transition, the society will be socialistic where the representatives of people should be responsible for the means of production and lead the society toward communism.

Socialism is a system between communism and capitalism. It seeks to redistribute the wealth more equitably by the communal ownership of natural resources and major industries like banking and public utilities. Socialists do not advocate violence or force to achieve their goals. Here, the means of production are in the hands of people either directly or through the government. Socialism differs from communism in the way that they do not believe that workers will remove capitalists from power suddenly and violently. Here, they encourage equal sharing of income and wealth among the people. In theory, this regime combines the best policies of both systems, but in practice the share government controls and response to market forces varies.

Neither the private nor the government sector alone can maintain the economy because both are important for the success of the system. Now-a-days mixed economies are popular. In theory, they are believed to combine the advantages of both command and market economic systems but in the real world, implementation of the same is not easy.

There is no entirely capitalist or communist economy in the world today. Example, like the capitalist United States has a Social Security system and a government-owned postal service and communist China permits its citizens to keep some of the profits they earn. Thus, the state has control over some areas whereas it provides incentives for firms to contribute in some sectors. This type of system has led to several imbalances in the distribution and allocation of resources.

Future Economic System

In the future which economic system is best for the world is still difficult to decide. Evolution of economic systems from slavery to market economy has been revolutionary. Thus, the science of economics will guide the development of future economies by promoting the needful and eliminating the inefficiencies with the goal to maximize social welfare.

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