Economic Systems
 

How do countries differ in the way their economies are organised?

All countries have some form of economic system.

At one extreme are the centrally planned or command economies economies that were formerly associated with communist countries (e.g. Soviet Union and China). These have now largely died out though Cuba remains a good example.

At the other extreme lie completely free-market economies where there is no government intervention and all economic decisions are taken by individuals and firms. There is no pure example of this as Governments intervene to some extent everywhere. However Singapore and Hong Kong and to a lesser extent the US represent economies where the free market philosophy is very strong.

In practice all economies are a mixture of both extremes (which can vary considerably) . In Europe the Scandanavian countries would have a high level of government intervention. Others like the Netherlands and the UK would have a lesser degree. Ireland stands somewhere in the middle as regards intervention.
 
 

The command economy
 

In the command economy land and capital are collectively owned. The state plans the allocation of resources at three levels

It decides on the important breakdown as between consumer and investment goods. In Stalin’s era a huge amount of resources went into investment (at the expense of the consumer).

It decides on the amount which each production unit will produce, and the techniques of production used

It decides on the distribution of resources as between consumers, generally by deciding on people’s incomes and then letting them make their own decisions as regards consumption.

There are lots of problems with the command economy.

It requires a huge amount of information and planning; planning can be inefficient; it can be hard to provide incentives for workers and it can involve a great loss of liberty for workers
 
 

The free market economy
 

This is also known as the capitalist (or laisser faire) system where land and capital are privately owned. Here consumers and producers are assumed to operate in their own self interest with all important decisions decided by the operation of supply and demand and resulting prices in the various markets throughout the economy.

With the price mechanism (Adam Smith’s invisible hand) there is no need for government intervention to allocate goods and services.

If the price is too low a shortage will build up where consumers will be willing to pay more. This will thereby cause price to rise. Alternatively when there is a surplus, the price will drop. Therefore through the adjustment of price, demand and supply are always brought into equilibrium with markets clearing at the price.

Therefore in free market systems efficiency is brought about through the willingness of both consumers and producers to follow price signals.

This enables a remarkably complex economy to evolve based on numerous markets without any need for direct intervention.

However the main weakness of the free market system is that it can be very inequitable.

Thus in practice we often have mixed economies whereby the state takes substantial control of social areas like education, health and social welfare.
 
 

Demand
 

The basic law of demand states that as the price of a good falls people will buy more of it. (Certainly Michael O’Leary of RyanAir believes in this law with his persistent emphasis on low air fares as the means to boost consumer demand!)

Alternatively when the price rises the quantity demanded will fall.

Therefore we can see that the Government in its attempt to reduce cigarette smoking keeps increasing the price in the budget!

The demand curve shows the relationship between price and quantity of the good in question (assuming all other factors affecting demand remain unchanged).

It slopes down from left to right showing that as the price falls more will be demanded.

However there are other factors which influence demand.

For example income is very important. When income goes up people will generally buy more of a good e.g. motor cars.

The prices of substitute (and complementary) goods are also significant. If the price of coffee was to rise sharply it would help tea sales (substitutes). If the price of petrol was to rise it could damage car sales (complementary).

Also tastes are important. Goods (not just clothes) can come in and go out of fashion (e.g. the recordings of various pop stars).

Advertising can influence demand. One of the reasons why Coca Cola remains so much in demand is due to successful advertising.

Also the weather can be a factor. For instance a long hot Summer would help beer sales!

In economics these other factors are shown through shifts in the demand curve (either left or right).
 

Supply

Similar dynamics work on the supply side. The supply curve is based solely on the relationship between price and quantity supplied (assuming other factors remain unchanged).

Thus when the price rises firms will be willing to produce more (due to the prospect of higher profit margins).

The supply curve thus slopes up from left to right.

As with demand other factors however can affect supply.

For example costs of production are often critical. Thus if a firm can reduce costs it will be willing to supply more (as with RyanAir) at the given price. This causes the supply curve to shift to the right.

Improvements in technology are also important (as they affect costs).

Weather conditions are very important especially in agriculture.

Also the government can affect supply through measures such as subsidies and taxation.
 

Determination of price

The price in an market is determined by the intersection of demand and supply.

The market comes into equilibrium at the price where supply = demand.

If the demand initially exceeds supply then this will lead to a shortage in the market with consumers willing to pay more. This will cause prices to rise!

If however supply exceeds demand this will lead to a surplus thus causing prices to fall.