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What are the three major types of economies? Explain the differences.

Economists classify economic systems into one of three distinct types, though by considering various forms of these you could certainly come up with four or more economic systems.  The three major types of economies are usually referred to as command, market, and mixed economies.

Before getting into the differences between these, let us think about what an economy is.  In any economic system, there must be a way for resources to be put to use to produce goods and services.  That is, an economy must decide how many workers and how much land to devote to producing peaches, and how much should be used to produce vacuum cleaners, and so on.  How these kinds of resource allocation decisions are made distinguishes the different economic systems.

In a command economy, these decisions are made by a central authority.  A command economy is therefore a form of central planning.  For example, a central government would decide how many peaches should be grown, how many vacuum cleaners should be made, and would also decide how much of the various resources would be allocated towards each good.  A major problem with this type of system is that it is difficult for a central authority to gather all necessary information to make the right decisions on how to allocate resources efficiently towards the production of each good and service. 

A pure market economy is the exact opposite. All decisions are made in a decentralized way, through the interaction of buyers and sellers in individual markets. That is, peach growers and vacuum cleaner builders would offer their goods, and depending on demand conditions, they would decide how many workers to hire, how much land to use, and how much to produce.  A major problem of a pure market system is that these individual decisions will not account for what economists call externalities.  For example, a pure market economy may result in too much production of a good that generates a great deal of pollution. 

For reasons like these, most economies are mixed economies.  In a mixed economy, many of the necessary decisions are made in decentralized markets, but there is also some degree of government intervention in the economy.  The U.S. is certainly a mixed economy.  Though markets are a key piece of our economic system, we also have federal, state, and local governments that enact various forms of regulation for the purpose of improving upon the outcome of a pure market economy. That is, a mixed economy like that in the U.S. is typically considered to be the best of both worlds.

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