Economic Systems

Definition of Economic System

An economic system may be defined as a medium or an organized way by which the means of production in a state are utilized in order to satisfy human wants.

Every society is faced with three fundamental economic problems and these problems center on what to produce, how to produce it and for whom to produce it. Although these problems are both fundamental and common to all economies, different economic systems are being applied to solve them in all societies.

An economic system consists of those institutions which a given people, nation or group of nations has chosen or accepted as the means through which their resources should be utilized for the satisfaction of their needs.

The Main Types of Economic Systems

The following are the main types of economic systems:

(1). Free or capitalist economic system (capitalism)

(2). Centrally-planned or controlled or socialist economic system (socialism)

(3). Mixed economic system

Free or Capitalist Economic System (Capitalism)

This is a system whereby the ownership and management of all means of production are vested in the hands of private individuals. It is operated in the USA, Japan, North America, New Zealand, Western Europe, Australia, Israel etc.

Features of Capitalism

The features of capitalism include the following:

  1. Ownership of private property, which includes accumulation of wealth and acts as an incentive to savings.
  2. Inheritance which is the right of an owner to designate the recipient of title to his property at the time of his death.
  3. Profit move, in which people’s economic activities are guided primarily by profit motives and the desire to maximize satisfaction.
  4. Competition, which helps in creating preserving efficiency In the production of goods.
  5. Freedom of individual initiative.

The Merits of Capitalism

The following are the merits or advantages of capitalism:

(1)  It facilitates a rise in the standard of living: The higher level of output and increased consumption resulting from freedom of production and consumption increase the level of material welfare.

(2) There is freedom of consumption and production: It increases the production of consumer goods under capitalism.

(3)  Technological advancement appears to be faster: The creativities among private individuals coupled with the use of machines in production leads to technological development.

(4)  Its flexibility and adaptability have permitted environmental changes

(5)  It encourages individual initiative and greater freedom to pursue his own    interest.

(6)  It leads to specialization: Large scale production in capitalism encourages specialization

(7) The system also leads to invention and innovation

(8) Capitalism creates room for effective use of talents

(9) Capitalism encourages economic competition among producers and consumers.

Demerits of Capitalism

The following are the demerits of capitalism:

  1. It brings about economic inequality.
  2. It encourages the acquisition of economic goods.
  3. It serves as an incentive to the creation of artificial scarcity.
  4. It brings about economic insecurity.
  5. It encourages individualism.
  6. It brings about wasteful use of productive resources.
  7. It widens the gap between the rich and the poor.


The Meaning of Socialism

This is a system whereby the ownership and management of all means of production are collectively owned and controlled by the state. Allocation of resources and distribution of goods and services are left in hand of the central authority.

Features of Socialism

The features of socialism include the following:

  1. State ownership of means of production.
  2. Promotion of social welfare.
  3. Centrally planned economy.
  4. Absence of price mechanism.
  5. Collective decision making.
  6. Absence of profit motive.
  7. Equitable distribution of income.

Advantages of Socialism

The following are the advantages or merits of socialism:

  1. Employment opportunities.
  2. Consumers are not exploited.
  3. No economic rivalry.
  4. Equitable distribution of income.
  5. Job security.
  6. Promotion of social welfare.
  7. Growth of private monopoly is checked.
  8. No overproduction of goods.
  9. Equitable allocation of resources.
  10. Centrally planned economy.

Disadvantages of Socialism

The following are the disadvantages or demerits of socialism:

  1. Growth of state monopoly.
  2. Absence of competition.
  3. Loss of consumer sovereignty.
  4. It reduces productivity.
  5. Economy is not self-regulating and functioning.
  6. It suppresses individual initiatives.
  7. Lack of innovations and inventions.
  8. Bureaucracy and red-tapism
  9. It slows down economics development.
  10. Absence of consumer choice and satisfaction.

Mixed Economy

This is an economic system in which the means of production and distribution are in the hands of both private and public sectors.

Features of Mixed Economy

The features of mixed economy include the following:

  1. Joint ownership of means of production.
  2. Joint decision.
  3. Freedom of choice.
  4. Provision of wealth services.
  5. Freedom of production, distribution and consumption.
  6. Government intervenes to regulate prices.
  7. Profit motive.
  8. Presence of competition.

Advantages of Mixed Economy

The following are the advantages or merits of mixed economy:

  1. Equitable distribution of wealth.
  2. It encourages growth and development.
  3. It encourages economy competition.
  4. Freedom of choice.
  5. Provision of welfare services.
  6. Prevention of monopoly..
  7. It encourages development of private initiative.
  8. It combines capitalism and socialism.

Disadvantages of Mixed Economy

The following are the disadvantages or demerits of mixed economy:

  1. Lack of efficiency
  2. Corruption and mismanagement
  3. Inequality of wealth
  4. It Leads to waste of resources
  5. Exploitation of labour
  6. Conflict of interest
  7. Emphasis on profit
  8. Existence of bureaucracy


  1. Differentiate between capitalist, socialist and mixed economic system.

How Each Economic System Solves Fundamental Economic Problems of Society

The ways by which each economic system solves fundamental economic problems of society are as follow:-

  1. What to produce
  2. How to produce
  3. For whom to produce

In capitalist economic, individual propelled by the profit motive to decide what should be produced and how best to produce it. Here, a person consumes whatever his income allows. Consumer determines what to produce.

In socialist economic, price does not play a crucial role as state decides what to produce and the method of production to be adopted. The government often introduces rationing of goods among the people.

In mixed economic, the state is guided by welfare consideration and private individuals by the profit motive. People consume whatever their money can buy but the state often provides some subsidized goods and services to all members of society.


  1. What is economic system?
  2. How would you describe the mixed economic system?State its merits and demerits
  3. Compare and contrast capitalism and socialism.

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