Economic Systems
| Author | Denise Woodbury |
| Pages | 220-223 |
Page 220
The fundamental economic problem in any society is to provide a set of rules for allocating resources and/or consumption among individuals who cannot satisfy their wants, given limited resources. The rules that each economic system provides function within a framework of formal institutions (e.g., laws) and informal institutions (e.g., customs).
In every nation, no matter what the form of government, what the type of economic system, who controls the government, or how rich or poor the country is, three basic economic questions must be answered. They are:
What and how much will be produced? Literally, billions of different outputs could be produced with society's scarce resources. Some mechanism must exist that differentiates between products to be produced and others that remain as either unexploited inventions or as individuals' unfulfilled desires.
How will it be produced? There are many ways to produce a desired item. It may be possible to use more labor and less capital, or vice versa. It may be possible to use more unskilled labor to substitute for fewer units of skilled labor. Choices must be made about the particular input mix, the way the inputs should be organized, how they are brought together, and where the production is to take place.
For whom will it be produced? Once a commodity is produced, some mechanism must exist that distributes finished products to the ultimate consumers of the product. The mechanism of distribution for these commodities differs by economic system.
Page 221
One way to define economic systems is to classify them according to whether they are market systems or command systems. In a market system, individuals own the factors of production and individually decide how to use them. The cumulative decisions of these individuals are reflected in constantly changing prices, which result from the supply and demand for different commodities and, in turn, impact that supply and demand. The prices of those commodities are signals to everyone within the system indicating relative scarcity and abundance. Indeed, it is the signaling aspect of the price system that provides the information to buyers and sellers about what should be bought and what should be produced.
In a market system the interaction of supply and demand for each good determines what and how much to produce. For example, if the highest price that consumers are willing to pay is less than the lowest cost at which a good can be produced, output will be zero. That does not mean that the market system has failed. It merely implies that the demand is not high enough in relation to supply to create a market; however, it might be someday.
In a market economy the efficient use of scarce inputs determines how output will be produced. Specifically, in a market system, the least-cost production method will have to be used. If any other method were used, firms would be sacrificing potential profit. Any firm that fails to employ the least-cost technique will find that other firms can undercut its price. That is, other firms can choose the least-cost or any lower-cost production method and be able to offer the product at a lower price, while still making a profit. This lower price will induce consumers to shift purchases from the higher-priced firm to the lower-priced firm, and inefficient firms will be forced out of business.
In a market system, individuals make the choice about what is purchased; however, ability to pay, as well as...
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