SSC CGL Economic Study Material – Economic Types
SSC CGL Economic Study Material – Economic Types
The purpose of every economy is to satisfy human wants by using limited or scarce resources available and known to a society. These wants can be satisfied by production and consumption of goods and services. For production, the factors of production are engaged in some economic activities. These economic activities bring income to the economic agents that can either be consumed or saved and invested. On account of these gainful economic activities and accumulated earnings, some countries grow fast while others cannot attain such high growth rate. As a result some economies attain the status of developed economies while others remain underdeveloped or developing economies. They are also known as rich and poor economies.
We can look at economies on the basis of ownership of resources. The resources available may be in private ownership or the collective ownership. Thus there are different ways to look at the economy and its level of development.
MEANING OF AN ECONOMY
An economy is a man-made organization for the satisfaction of human wants. According to A.J. Brown, “An economy is a system by which people get living”. The way man attempts to get a living differs in major respects from time to time and from place to place. In primitive times ‘get a living’ was simple but with growth of civilization it has become much more complex. Here it is important to note that the way person earns his/her living must be legal and fair. Unfair and illegal means such as robbery, smuggling may earn income for oneself but should not be taken into consideration as gainful economic activity or a system of ‘get a living’. It will therefore be appropriate to call that economy is a framework where all economic activities are carried out.
Some of the salient features of an economy are as follows:
- Economic institutions are manmade. Thus an economy is what we make it.
- Economic institutions can be created, destroyed, replaced or changed. For example the capitalism was replaced by communism in 1917 in USSR and the communism was destroyed in 1989 through a series of economic reforms by former USSR. In India after independence in 1947 through economic and social reforms we abolished Zamindari system and introduced many land reform.
- Levels of economic activities keep on changing.
- Producers and consumers are the same persons. Thus they have a dual role. As producers they work and produce certain goods and services and consume the same as consumers.
- Production, consumption and investment are the vital processes of an economy.
- In modern complex economies we use money as a medium, of exchange.
- Now-a-days the government intervention in the economy is considered undesirable and the preference for free functioning of prices and market forces is increasing in all types of economic system.
Types of Economies
As you know that economy is a man-made organization, which is created, destroyed or changed as per the requirement of the society. We can differentiate in various types of economic systems on the basis of following criteria.
On the Basis of Ownership and Control over Means of Production or Resources
Resources or means of production remain either in private ownership with full individual freedom to use them for the profit motive or they can be in collective ownership (government control) and can be used for the collective welfare of the society as a whole. Based on the criterion of degree of individual freedom and profit motive, economies are labelled as:
(A) Capitalist or free enterprise economy
(B) Socialist or centrally planned economy
(C) Mixed economy
Now we shall discuss about the main characteristics of these economics in brief.
The capitalist or free enterprise economy is the oldest form of economy. Earlier economists supported the policy of ‘laissez fair’ meaning leave free. They advocated minimum government intervention in the economic activities.
The following are the main features of a capitalist economy;
(i) Private property
In a capitalism system all the individuals have the right to own property. An individual can acquire property and use it for the benefit of his own family. There is no restriction on the ownership of land, machines, mines, factories and to earn profit and accumulate wealth. After the death of a person the property or wealth is transferred to the legal heirs. Thus the institution of private property is sustained over time by the right of inheritance.
(ii) Freedom of enterprise
In a capitalist economy the government does not coordinate production decisions of the citizens. Individuals are free to choose any occupation. Freedom of enterprise implies that business firms are free to acquire resources and use them in the production of any good or service. The firms are also free to sell their product in the markets of their choice. A worker is free to choose his/her employer. In small business units owner himself takes the risk of production and earns profit or loss for himself. But in modern corporations the shareholders take risks whereas paid directors manage business. Thus the individual supervision of one’s own capital is now no longer required to earn profit. Government or any other agency does not impose restrictions/obstacles in the way of workers to enter or leave a particular industry. A worker chooses that occupation where his income is maximum.
(iii) Consumer’s Sovereignty
In a capitalist economy consumers are like a king. They have the full freedom to spend their income on goods and services that give them maximum satisfaction. In capitalist system production is guided by consumer’s choices. This freedom of consumers is called consumer’s sovereignty.
(iv) Profit Motive
Self-interest is the guiding principle in capitalism. Entrepreneurs know that they will own the profit or loss after the payment to all other factors of production. Therefore they are always motivated to maximize their residual profit by minimizing cost and maximizing revenue. This makes the capitalist economy an efficient and self-regulated economy.
There are no restrictions on the entry and exit of firms in a capitalism system. The large number of producers are available to supply a particular good or service and therefore no firm can earn more than normal profit. Competition is the fundamental feature of capitalist economy and essential to safeguard against consumer’s exploitation. Although due to large-size and product distinction monopolistic tendencies have grown these days still the competition can be seen among a large number of firms.
(vi) Importance of markets and prices
The important features of capitalism like private property, freedom of choice, profit motive and competition make a room for free and efficient functioning of price mechanism. Capitalism is essentially a market economy where every commodity has a price. The forces of demand and supply in an industry determine this price. Firms which are able to adjust at a given price earn normal profit and those who fail to do so often quit the industry. A producer will produce those goods, which give him more profit.
(vii) Absence of government interference
In a free enterprise or capitalist economy the price system plays an important role of coordinating agent. Government intervention and support is not required. The role of government is to help in free and efficient functioning of the markets.
Limitations of Capitalist Economy
- Inequalities: Capitalism creates extreme inequalities in income and wealth. The producers, landlords, traders reap huge profits and accumulate wealth. Thus the rich become richer and the poor poorer. The poor with limited means are unable to compete with the rich. Thus capitalism widens the gap between the rich and the poor creating inequality.
- Leads to Monopoly: Inequality leads to monopoly. Mega corporate units replace smaller units of production. Firms combine to form cartels, trusts and in this process bring about reduction in number of firms engaged in production. They ultimately emerge as multinational corporations (MNCs) or transnational corporations (TNCs). They often hike prices against the welfare of consumer.
- Depression: There is over-production of goods due to heavy competition. The rich exploit the poor. The poor are not able to take advantage of the production and hence are exploited. At another level, over-production leads to glut in the market and hence depression. This leads to economic instabilities.
- Mechanisation and Automation: Capitalism encourages mechanization and automation. This will result in unemployment particularly in labour surplus economies.
- Welfare ignored: Under capitalism, private enterprises produce luxury goods which give higher profits and ignore the basic goods required which give less profit. Thus the welfare of public is ignored.
- Exploitation of Labour: Stringent labour laws are enacted for the exclusive profit-motive of capitalists. Fire and hire policy will become the order of the day. Such laws also help to exploit the labour by keeping their wage rate at its lowest minimum.
- Basic social needs are ignored:–There are many basic social sectors like literacy, public health, poverty, drinking water, social welfare, and social security. As the profit margin in these sectors is low, capitalists will not invest. Hence most of these vital human issues will be ignored in a capitalist system.
Capitalism in today’s world
Pure capitalism is not seen in the world now-a-days. The economies of USA, UK, France, Netherland, Spain, Portugal, Australia ect. are known as capitalistic countries with active role of their respective government in economic development.
(B) Socialist Economy
In the socialist or centrally planned economies all the productive resources are owned and controlled by the government in the overall interest of the society. A central planning authority takes the decisions.
The socialist economy has the following main features.
(i) Collective Ownership of means of Production
In a Socialist economy means of production are owned by the government on behalf of the people. The institution of private property is abolished and no individual is allowed to own any production unit and accumulate wealth and transfer it to their heirs. However, people may own some durable consumer goods for their personal use.
(ii) Social Welfare Objective
The decisions are taken by the government at macro level with the objective of maximization of social welfare in mind rather than maximization of individual profit. The forces of demand and supply do not play any important role. Careful decisions are taken with the welfare objectives in mind.
(iii) Central Planning
Economic planning is an essential feature of a socialist economy. The Central Planning Authority keeping the national priorities and availability of resources in mind allocates resources. Government takes all economic decisions regarding production, consumption and investment keeping in mind the present and future needs. The planning authorities fix targets for various sectors and ensure efficient utilization of resources.
(iv) Reduction in Inequalities
The institutions of private property and inheritance are at the root of inequalities of income and wealth in a capitalist economy. By abolishing these twin institutions a socialist economic system is able to reduce the inequalities of incomes. It is important to note that perfect equality in income and wealth is neither desirable nor practicable.
(v) No class conflict
In capitalist economy the interests of the workers and management are different. Both of them want to maximize their own individual profit or earnings. This results in class conflict in capitalist economy. In socialism there is no competition among classes. Every person is a worker so there is no class conflict. All are co-workers.
Limitations of Socialist Economy
(i) Loss of Consumer Sovereignty:
A consumer has no choice of his own, he acts as a mere slave under this system. Government produces goods and services keeping in view the needs of the people.
(ii) Less Democratic:
Socialist economy is always less democratic as it possesses no element of freedom. It is also like government dictatorship.
(iii) No Automatic Functioning:
Under this system, no automatic function in system exists at all. It is the Central Authority, i.e., government that governs the country according to its own interest.
(iv) Evils of Bureaucracy
In socialist economy, all economic activities are controlled by the government. Thus, they develop all evils of bureaucracy like favouritism, delay; corruption and other sue evils,
(v) Rigid Economy:
Socialist economy is very rigid and not susceptible to change according to requirements. Hence people work like a machine and never get any incentive to work.
(vi) Burden on Government:
All the economic activities are performed by the Central Authority on behalf of the government. Hence, it is overburdened with daily activities and, therefore, it gets very less time to think and plan for the economic prosperity of the economy.
(vii) Expenditure on Planning:
In fact, planning is a long process in a socialist economy. This expenditure is unnecessarily wasteful and a burden on the national economy.
Socialism in today’s world
Countries such as Russia, China and many eastern European countries are said to be socialist countries. But they are changing now and encouraging liberalisation in their countries for their economic development.
(C) Mixed Economy
A mixed economy combines the best features of capitalism and socialism. Thus mixed economy has some elements of both free enterprise or capitalist economy as well as a government controlled socialist economy. The public and private sectors co-exist in mixed economies.
The main characteristics of a mixed economy are as follows:
(i) Co-existence of public and private sectors.
The private sector consists of production units that are owned privately and work on the basis of profit motive. The public sector consists of production units owned by the government and works on the basis of social welfare. The areas of economic activities of each sector are generally demarcated. Government uses its various policies e.g. licensing policy, taxation policy, price policy, monetary policy and fiscal policy to control and regulate the private sector.
(ii) Individual Freedom
Individuals take up economic activities to maximize their personal income. They are free to choose any occupation and consume as per their choice. But producers are not given the freedom to exploit consumers and labourers. Government puts some restrictions keeping in mind the welfare of the people. For instance, government may put restrictions on the production and consumption of harmful goods. But within rules, regulations and restrictions imposed by the government, for the welfare of the society the private sector enjoys complete freedom.
(iii) Economic Planning
The government prepares long-term plans and decides the roles to be played by the private and public sectors in the development of the economy. The public sector is under direct control of the government as such production targets and plans are formulated for them directly. The private sector is provided encouragement, incentives, support and subsidies to work as per national priorities.
(iv) Price Mechanism
Prices play a significant role in the allocation of resources. For some sectors the policy of administered prices is adopted. Government also provides price subsidies to help the target group. The aim of the government is to maximize the welfare of the masses. For those who cannot afford to purchase the goods at market prices, government makes the goods available either free of cost or at below market (subsidized) prices.
Thus in a mixed economy people at large enjoy individual freedom and government support to protect the interests of weaker sections of the society.
Indian economy is considered a mixed economy as it has well defined areas for functioning of public and private sectors and economic planning. Even countries such as USA, UK, etc. which were known as capitalistic countries are also called mixed economies now because of active role of their government in economic development.
Limitations of mixed economy
Some economists claim that mixed economy is most unstable in nature. The public sector gets maximum benefits whereas private sector remains controlled.
(ii) Ineffectiveness of Sectors:
Under this system, both the sectors are ineffective in nature. The private sector does not get full freedom, hence it becomes ineffective. This leads to ineffectiveness among the public sector. In true sense, both sectors are not only competitive but also complementary in nature.
(iii) Inefficient Planning:
There is no such comprehensive planning in mixed economy. As a result, a large sector of the economy remains outside the control of the government.
In this system, both sectors suffer due to lack of efficiency. In public sector it is so because government employees do not perform their duty with responsibility, while in private sector, efficiency goes down because government imposes too many restrictions in the form of control, permits and licenses, etc.
(v) Delay in Economic Decisions:
In a mixed economy, there is always delay in making certain decisions, especially in case of public sector. This type of delay always leads to a great hindrance in the path of smooth functioning of the economy.
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