Chapter 3
Economic systems
• Economic systems are methods used by countries to allocate their resources.
Reasons for countries to follow a particular system.
• The stage of development of a country
• The system of government in a country
• The preferences of the inhabitants of the country
• The language, culture, tastes, customs and environmental factors such as what can be grown.
1. The free market economy
This system is also known as capitalism as it uses supply and demand to respond to what, how
and for whom to produce goods and services for.
Economic activities in this system are regulated by the consumer, producer, pricing of goods and
the profits made from selling goods and services
Characteristics of a free market economy
• The market forces of demand and supply determine what, how and for whom to
produce goods and services.
• Prices act as signals in the free market economy. This helps prevent surpluses ad
shortages of supply.
• Individuals can act on his or her own initiative and has freedom of choice with regards
to all economic activities.
• Most factors of production are privately owned
• Under a pure capitalism, there is zero government intervention
• Profit motive is at the heart of this economic system
Advantages of a free market economy
• Private ownership of factors of production is the backbone of free markets. This
encourages individuals to utilise their resources in a way that will maximise their wealth
• As factors of production are privately, individuals will be more efficient in the use of
resources.
• Freedom of entry in the markets by new businesses who are attracted to profits results
in competition. This results in high choice for consumers.
• Business are not able to dominate markets and exploit consumers
• Huge profits and economic progress are often features of upswing in the economic and
this reflects an increase in overall welfare
Disadvantages of a free market economy
• This economic system can lead to high levels of inequality
• Each individual pursues the greatest possible satisfaction and this can sometimes be
at the disadvantage of others.
• Own self-interest outweighs social interest
• Businesses only produce goods and services that have high demand. Other
important goods and services are only provided for those that can afford them.
• Demerits goods may be overprovided if they can generate enough profits.
• Downswing phases in the economic growth rate often in unemployment and
poverty.
2. Centrally planned economy
In this system the government determines what, how and for whom to produce goods and
service. It is also referred to as communism and socialism.
Characteristics of a centrally planned economy
• The state is the biggest economic entity in the economy employing vast amount of
labour to execute its economic policies from a central position. This however, create
bureaucracy.
• Private initiative and free choice of the individual is limited or even non-existent.
• The factors of production cannot be privately owned and controlled by individuals.
Instead the state controls all resources for the benefit of citizens.
• The states guides the needs and wants of the consumers by providing essential goods
and services for all in equal quantities.
• Goods and services are limited to the most essential. To avoid shortages, the
distribution of goods and services is organised by way of coupon system.
Advantages of a centrally planned economy.
• The system tries to serve the needs of the community and not those of the individuals.
It ensures total equity in terms of welfare.
• Long term planning takes place, meaning that the economy can be carefully controlled
and steered in a particular direction
• Resources can be managed in a central and controlled way. As the state is the main and
only producer. There is less exploitation of natural resources the environment
experiences less deterioration
• There is full employment as the state creates jobs for all.
Disadvantages of a centrally planned economy
• Bureaucracy can lead to very inefficient allocation resources as it will require a huge
amount of administration by the civil servants who may not be experienced or trained
to do so.
• Long term planning makes the system inflexible to adapting to short- and medium-term
changes in the needs of consumers. This may result in surpluses and shortages of goods.
• There is limited scope for private initiative and individual choice resulting in low
productivity and low quality of output
• Products are standardised and luxury goods are regarded as unnecessary.
3. South Africa’s mixed economy
This is an economic system that combines the advantages of both economic systems.
Characteristics of a mixed market economy
• Most factors of production are privately owned but the government regulates it. The
government intervenes to correct the market failure if there are inefficiencies.
• People use their own initiative to manufacture and sell products and render services to
satisfy consumers needs and wants.
• The extent to which economic activities are market oriented depends on the level of
government involvement. If the GDP is made up of 35% to 60% of state expenditure that
that state will be regarded as the social welfare state.
• The public sector provides infrastructure and public services as there is little profit
motive for these to be provided by the free market.
Advantages of a mixed market economy
• Private ownership is one of the most important advantages of this system. Individual
creativity and entrepreneurial endeavour drive the economy.
• The size of the government does not have to be bigger than what is necessary.
• Ownership of possession, for example, a house or a car is transferable. Individuals have
a freedom of choice.
• While the entrepreneurship and freedom of choice creates competition between
businesses, the state is still on hand to provide essential public goods and services
Disadvantages of a mixed market economy
• Market failure occur when scarce resources are wasted or exploited due to incorrect
production decisions or greed by private businesses.
• Capitalists believe that mixed economies are hampered by state intervention but
socialists argue that some mixed economies are too free. Getting the right mix is difficult
• Depending on the level of state intervention, taxes may be too high to fund the public
sector or they may be too low.
• Because factors of production are in the hands of individuals. individuals are at a risk of
possible losses or bankruptcy
• The quality of goods and services may be inferior because of a lack of control by the
state and the cost cutting ruthlessness of the profit-oriented businesses.
