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Questions and Answers
What are the three basic 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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