Meaning and Types of Economic System


Meaning and Types of Economic System

In understanding economics science and its methodologies, there is the need to thoughtfully consider the intricacies of people, resources, agents, institutions and their mechanism. Economics studies the relationship between the people and the institutions in a society with the limited scarce resources in that society.

Consequently, there is the need to answer basic economic problems. These questions are answered in different methods, these methods determines the type of economic system that a country is operating. As mentioned earlier, the concern of each economic determines its methodology.

Capitalist Economy is usually concerned with an occupational freedom, while the aim of a SocialistEconomy is social control over major but selected productive activities.

In the same vein, Communist economy system takes control of all major sources of production. In socialist and communist economies, basic economic decision are made by the government while in Market economy, these decisions are made by the invisible hand of market forces. Another methodology of economics science is Market economy where the mechanism is based on free market and free prices.

However, in a Mixed Economy there is the permutation of both capitalist and socialist economies. Therefore, a big concern is on how the available resources would be allocated, to get maximum total output.

Overview of Economics System

Different individuals live together in a community with a set of objectives and shared values. A community is a place where these individuals with set of objectives and shared values interact.

In a group of people in a community or society, each individual possibly may have different and competing objectives. As a result, social institutions emerge to resolve the conflict between individual objectives. People of similar objectives usually meet together as a result of demand and supply of goods and services. Their meeting place is referred to as the market.

Market is a social institution where people of similar objectives meets to exchanges values and meet their demands. In doing this, different types of economic decision making processes are adopted by the individual and social institutions. Social institutions have its influence on human behavior which determines their decisions in answering basic economic problem.

Definition of Economic System

An economic system consists of individual, institutions and their interaction in the process of answering basic economic problems.

Individual and institutions work together to answer basic economic problems in relation to the resources in the society, its scarcity and how these scarce resources can be allocated to meet conflicting and diverse objectives. The mechanism of production, distribution and consumption varies in our society. This is because each society answers the basic economic problems in different ways. How each society answered the basic economic problems; that is the economic decisions they make; determines the type of economic system they will operate.

In the economic decision making, we have the households as the major actor followed by the institutions and then the government. North (1990) posited that institutions are the rules of the game in a society. Formally, they are the humanly devised constraints that shape human interaction which means they influence human behavior. In consequence they structure incentives in human exchange, whether political, social, or economic. Institutional change shapes the way societies evolve through time and hence it is the key to thoughtful historical change.

An economic system must be able to answer basically three of the economic problems such as:

What to produce? That is what types of goods and services to produce.

How to produce? That is what the resources available that can be employ for production of goods and services.

For whom to produce? That is; who is the receiver of the final products from production.

Hence an economic system encompasses various processes of organizing and motivating labor, producing, distributing, and circulating of the fruits of human labor.

Fruit of labor refers to products and services, consumer goods, machines, tools, and other technology used as inputs to future production, and the infrastructure within and in the course of which production, distribution, and circulation arises.


Types of Economic Systems

Economic decision made by a society shapes the economic system of that Country.

The Figure 1: shows the basic economic systems:

Types of Economic Systems

1. Traditional economy

2. Controlled economy

3. Free market Economy

4. Mixed economy

1. Traditional Economy

In a traditional economy, the economic decisions are made based on believes, norms religion and customs of that society. Specifically the economic decision on economic questions of what to produce, how to produce, for whom to produce, where to produce etc. are made based on believes, religion, customs, habit and norms of that society. For instance, the economies of some countries are believed to be traditional.

Arab and African Countries such as Saudi Arabia, Nigeria, Iran, Pakistan, Kenya, Ghana, Qatar etc where people produce what they learnt their forefathers produced, following their custom of producing it; sell products that are produced the same way their forefathers produced it are traditional economies. For instance in Nigeria, people of Abeokuta is known for the ‘adire’ cloth business while the Oke-ogun people continue to produce the ‘ofi’ traditional attires.

Barter-direct exchange of goods and services with other goods and services are part of the norms. For instance in Yoruba land, an exchange of food for services called ‘agbaro’ is still in operation in some part of the land. ‘Agbaro’ means that a group of friend will assist a member of the group to clear a portion of land while they receive in turn, food for their services instead of money. This is done based on custom of friendship.


There is usually a strong family or societal relationship between the individuals in the traditional economy. Hence, there may be economic securities and safety for members of the society. This in turn may promote economic stabilities in the traditional economy.


Lack of innovation or resistance to innovations. Such technical know how may be monopolized by the family that specialized in a certain profession. Modern ideals may not be welcome because they usually want to do things the same way it was done before they were born.

2. Controlled Economy

In a controlled economy, it is the government that makes the economic decision and it is solely done meaning that there are no private sector initiatives. Government planners decide on what to produce, how many shoe industry will produce the number of shoes the government decided should be produced. How to allocate resources to the producer is the business of the government planners. Controlled or Planned economies are usually associated with Socialism and Communism where government determines the wages of workers, the prices of goods and services and level of output. Former Soviet Union, Cuba, Germany, Russia, North Korea etc are close examples of Controlled or Planned economies. Albeit, Germany and Russia seems to have move to mixed economy as it is the case with countries under other economic system.


Ability to accomplish social goals quickly. Planning for more labor in production in a control economy can reduce unemployment. There is plausible provision of more economic securities to the participant in this economy. This type of economy may be able to provide an equal distribution of income and goods and services.


It is difficult for Controlled economy to match consumer’s wants and needs with the productions. Complexity of production may lead to production problems. The economic participants may have to depend on a small number of economic choices as provided by the government planners. There may be overproduction of some products and underproduction of other products.

3. Free Market Economy

Free market economy or market economy is an economic system where the basic economic decisions are made by the buyers and sellers, individual households and businesses in the economy through the price mechanism. Unlike the controlled economy where private sectors are non- existence; free market economy allow individuals to operate their own businesses and answer economic problems using their owned resources, make profits and determine the prices of goods and services.

Companies and businesses can choose cost effective method of production to maximize profit and minimize cost of production. For example, adire cloth can be made using the traditional hand methods, the modern machine and combination of the two methods. If the combination of the two methods is the cheapest method of production, then the company will go for it. It should be noted that Government interventions in free market economy is not allowed.


There may be a good opportunity for innovation and incentive to produce. There is usually economic freedom in a free market economy.

There may be a direct link between the buyer and the seller through price mechanism.


There may be few incentives to protect the environment. Market power may be concentrated in the hand of few. People without marketable skill may lack adequate protection.

4. Mixed Economy

The economic decision on what to produce; how and where to produce; for whom to produce; is made jointly by the government and the private sectors in the economy. This is achieved through the demand and supply mechanism (price and profit) based on free market enterprise. Mixed economy is a combination of controlled economy and market economy.

Most economies of the world show evidence pointing to characteristics of mixed economy. Therefore, we may conclude that there is no pure controlled; traditional or free market economy. Countries like Nigeria,

United State of America, United Kingdom, Malaysia, China and all modern economies are mixed economies. It should be noted that in a mixed economy, government intervention is limited somehow to market regulation in the business and household sector as well as input and output market. This is because businesses own resources, they also determines how the resources are put into use. That is what to produce, to whom to produce and how to produce. There should not be government intervention in a truly free-market economy. But as a result of the mixed economy, government serves as regulators to some sectors or industries in the economy.


There is effectiveness in achieving social goal. There is likelihood or providing economic security


There may be lack of incentives to create quality goods and services.

There may be lack of environmental protection.

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