Economic systems and types of goods

Last time

Before we start: last time, in Public goods, merit and demerit goods and information failure, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Who decides?

Every economy answers what, how and for whom to produce. A market economy leaves it to prices, a planned economy to the state, a mixed economy to both. This lesson compares the systems and the types of goods they produce.

The market economy

In a market economy, resources are privately owned and allocated through the price mechanism, by the decisions of consumers and firms. Advantages: consumer sovereignty, efficiency from competition, choice and innovation. Disadvantages: market failure, such as public goods not provided, merit goods under-consumed, externalities and inequality.

The planned economy

In a planned economy, the state owns most resources and decides production through central planning. Advantages: it can provide public and merit goods, reduce inequality, and direct resources to national priorities. Disadvantages: without price signals, planners face an information problem, leading to shortages, surpluses and little innovation.

The mixed economy

A mixed economy has a private sector and a public sector. Almost all economies are mixed. The state intervenes to correct market failure: providing public goods, regulating, taxing and subsidising. The debate is about the size of the state sector, not whether one should exist.

A large or small state sector?

A larger state sector can provide more public and merit goods and reduce inequality, but may be inefficient and need high taxes. A smaller state sector relies on markets for efficiency and incentives, but risks more market failure and inequality. The best size depends on the economy's level of development, its institutions, and its people's priorities.

Transition economies

Some economies have moved from planned to market systems, by privatising state firms and freeing prices. This can raise efficiency and growth, as in China's reforms, but can bring unemployment and inequality during the change. The speed of change matters: sudden change can be painful.

Free goods and economic goods

A free good has no opportunity cost: it is not scarce, such as air in most places. An economic good is scarce: producing it uses resources with an opportunity cost. A good can change type: clean water was free in many places and is now an economic good.

Private goods

A private good is excludable: people who do not pay can be stopped from using it. And rival: one person's use reduces what is available to others. Markets provide private goods well, because firms can charge for them.

Why the distinction matters

Economic goods must be allocated, by price or by the state; free goods need no allocation. Private goods can be left to markets; public goods, which are not excludable, will not be provided by markets. So the type of good decides whether the market can provide it efficiently.

Mistakes that lose marks

Mistake one: saying a planned economy has no prices at all. It may have prices, set by the state. Mistake two: defining a private good only as one bought privately, without excludable and rival. Mistake three: an evaluation with no conclusion on the size of the state. The fix: characteristics, and a judgement that depends on circumstances.

The full-marks tip

The full-marks tip: define goods by their characteristics: scarcity, excludability and rivalry. For systems, evaluate with: it depends on development, institutions and priorities.

On one card

So, on one card: economic systems and goods. Keep it for revision.