Economic Systems

Economic systems are methods of resource and product allocation. They can be divided into three categories: tradition, command, and markets.

An economic system based on tradition allocates economic resources and they products they produce by custom. A dowry, in which the family of the bride gives money or property to the bridegroom at marriage, is an example of the allocation of resources by tradition. Since a woman with a large dowry attracted many potential suitors, the custom developed as a way for families to increase the likelihood that their daughter would be well provided for in the future. A different tradition developed to ensure that prestigious estates retained the family name. If inheritances were divided among the offspring, then a large, impressive estate might be reduced to a series of small, unimpressive estates in a few generations. Since it is customary in many cultures for a woman to take her husband’s family name upon marriage, any inheritance given to daughters may lose the family name. Consequently, it is traditional in many societies throughout history to pass inheritances to the first-born male child.

In an economic system based on command, one person or a small group of people allocates economic resources and products for a larger group of people. Fidel Castro’s direction of resource and product allocation in Cuba is an example of economic allocation by command. The Communist government’s allocation of products and resources in the former Soviet Union is another example of allocation by command.

A market-based economic system uses prices to allocate economic resources and products through the separate decisions of households and business firms. A household is a social unit comprised of those living together in the same dwelling. A business or business firm is a company that produces goods or services, usually in an effort to make a profit. A person purchasing an item from a store is an example of a market transaction. A business hiring a worker is another example.

In the real world, none of these economic systems exists in a pure form. Every economy is a combination of tradition, command, and markets.

Some countries, such as China, North Korea, and the former Soviet Union, try to rely most heavily on command for the allocation of resources. Even in these societies, however, markets play an important role. When a market is illegal, it is referred to as a black market. The name is derived from illegal activity occurring in the darkness of shadows so as not to be detected by legal authorities.

Most economies in the world rely more heavily on markets to allocate resources than on tradition and command. This is primarily because markets are more efficient.

The reunification of Germany is illustrative of the differences between societies that rely on markets versus those that rely on tradition and command. Prior to reunification, West Germany relied most heavily on markets for the allocation of its resources, while East Germany was a command-based economy. After the fall of the Berlin Wall in 1991, however, the rest of the world learned that the economic conditions in West Germany were far superior to those in East Germany.

The collapse of the Soviet Union, another command-based economy, and the movement of Russia and the Newly Independent States (NIS) toward economic systems with a greater emphasis on markets also indicate the relative efficiency of markets in allocating resources and products.