An “economic system” is the set of institutions within which a community decides what, how and for whom to produce goods and services. At one extreme there is the centrally planned or command economy and at the other the free market economy. In between is the mixed economy that is some combination of the two extremes.
Centrally Planned or Command Economy: Where all decisions pertaining to economics are taken by a central authority. It is characterised by collective ownership of resources therefore the price mechanism does not operate e.g. Cuba or North Korea.
A Market Economy is a free enterprise, laissez-faire or capitalist economic system. Land and capital are privately owned. An economy that decides what, how and for whom goods and services are produced by channelling individual choice through a market is called a market economy. Markets consist of large numbers of buyers and sellers and price is determined by supply and demand. Adam Smith and the classical economists held that the “invisible hand” leads to desirable market outcomes.
Mixed Economy: A Mixed economy contains a mixture of private enterprise and state involvement in production and distribution. The reasons for government involvement are:
• To provide goods and services that private industry will not or cannot supply.
• To correct inequalities in the distribution of wealth between individuals.
• To curb monopoly power.
• To overcome frictions e.g. in the movement of labour; and
• To relieve shortages e.g. housing.