Solving the Central Problems in various types of Economic Systems:

Solving the Central Problems in various types of Economic Systems:

There are some basic or central economic problems common to all kinds of economic systems. These are:

              i.   What commodities are to be produced and in what quantities?

            ii.   How shall goods be produced?

          iii.   For whom shall goods be produced?

          iv.   How much to consume and how much to save and invest for future generations.

Free Enterprise Economy:

The economic principles works on the principle of “laissez faire” i.e. the least interference by the government or any external force. The primary role of the government, if any, is to ensure free working of the economy by removing obstacles to free competition and price mechanism.

A free enterprise economy or a capitalist economy is characterized as follows:

·         Means of production are privately owned by the people who acquire and possess them;

·         Private gains are the main motivating and guiding force for carrying out economic activities;

·         Both consumers and firms enjoy the freedom of choice, consumers have freedom to consume what they want to and firms have the choice to produce what they want to;

·         There exists a high degree of competition in both commodity and factor markets; and

·         There is least interference by the government in the economic activities of the people; the government looks after only internal and external security and public utility services. Adam smith says, “That government is best which governs the least.”

All the Central problems are solved by the free functioning of the forces of demand and supply through price mechanism (see Diagram). In case of any mismatch in the forces of demand and supply prices set them right.

                                    

System of interdependence between supply of a good or service and demand of the goods and service is handled by price mechanism. Whenever the supply is below demand prices move up and when supply exceeds demand prices move down. The equilibrium is restored in the market by the free functioning of the prices. In case of the labour market the wage rate sends the signal which is the price of labour. Higher wage rate provides signal to the unemployed to join the market.

Centrally Planned Economy:

Unlike market economy in which private owners take the production decisions in centrally planned economy allocation of resources is determined by comprehensive plan of production which specifies the output requirement. The government-controlled economies are also called Commend Economies, or Centrally Planned economies. Such economies are controlled, regulated and managed by the government agencies. The other characteristics of the Socialist economy are:

·         Means of production are owned by the society or by the state in the name of the community- private ownership of the factors and property is abolished;

·         Motive of the economic activities is welfare of the people,

·         Freedom of the choice of the consumers is curbed what society can afford for all, and

The role of market forces and competition is eliminated by law.

Command economies have certain advantages over free market economies, especially in terms of the coordination of scarce resources at times of crisis, such as a war or following a natural disaster state owned enterprises take production decisions in the best interest of the society.

Mixed Capitalist Economy:

A mixed capitalist economy is a mixture of capitalist and socialistic society biased towards capitalism. The economies of highly developed nations like U.S., U.K., France, Japan etc. fall in this category. These economies have both public and private sectors. Private sectors work on the principles of free enterprise system. The government plays significant role in preserving capitalist mode of production, ensuring a workable competition in factor and product markets, providing infrastructure for promotion of private sector economic activities.

Mixed Socialist Economies: The Socialist economies are in fact mixed economies biased towards socialism. The former communist countries like Russia, China were in this category. These economies have now carried out drastic economic reforms and have adopted liberalized economic system, private property and profit motive. The government of these countries control and regulate economies in accordance with the plan objectives.

Solving the Central problems

        All economies in the words face some central problems and they are common irrespective of the category they belong. The major economic problems may be micro –problems or they may be macro problems. Micro-economic problems are the basic problems, which are, related to the working f the constituents of the economic systems, and macro- economic problems relates to the growth, stability and full employment in the economy. The way in which these central problems are solved depends on the nature of the economy. The capitalist society solves these problems with the help of price mechanism whereas the socialist society solves these problems with the help of central planning. Though free enterprise economy is competent of bringing high economic growth it does not ensures the stable, sustained, and balanced growth. It becomes therefore inevitable for the government to introduce a free and fair competition and help the economy in achieving its goals- efficiency, stability, growth and social justice.

Now, the question arises as to what should be the role of government in the economy or what should be the form nature and extent of government intervention in the free functioning of the market forces. Nevertheless, the economic role of the government can be broadly categorized based on the three economic systems, which presently prevail in the world, viz., Capitalism, socialism and the mixed economy. In a capitalist system, the primary role of the government is (i) to preserve and promote market mechanism wherever it is possible to ensure a workable competition. (ii) To remove all unnecessary restrictions on the free operation of competitive market, and (iii) to provide a legal framework so that free competition can work effectively. Thus, the role of the government in a capitalist society is limited to (i) restoration and promotion of necessary conditions for efficient working of free market forces, ant (ii) to enter those areas of production and distribution in areas where private sector is not coming forward or the private sector is inefficient. 

In a socialist economic system, the role of government is more exhaustive and it controls almost all economic activities. In the socialist system, not only there is a complete disregard for free enterprise and market economy but also these systems are abolished by law. The private ownership of the factors of production is replaced by the government ownership. All economic activities are centrally planned, controlled and regulated by the government.  All decisions regarding production of resources, allocation, employment, pricing etc., are taken by the Central Planning Authority.

In a mixed economy, the private sector is allowed to function on the principles of free enterprise economy or market mechanism. The public sector on the other hand works based on socialist pattern. The public sector is created by reserving certain industries, trade, services, and activities for the government control and management. Another way of creating public sector is nationalisation of existing industries, which the government thinks necessary for promoting social welfare. Government also controls the private sector industries by enacting certain laws, rules and policies. If necessary, direct controls are also imposed.

The relationship between Business and its environment can be summarized as follows:

There is a symbolic relationship between business and its environment and among environmental factors. In other words, business is influenced by its environment and in turn, it influences the external forces. Similarly, political-legal environment influences the economic environment and vice versa. In the same way, the social environment influences all other factors.

These environmental forces are dynamic. They keep on changing with time, so do business.

The third influence is that a particular business firm by itself may not be in a position to change its environment.  However, along with other firms business is in a position to change the environment in its favour.

Thus, the study of business environment helps in the development of broad strategies and long-term policies of the firm.  It helps to foresee the impact of socio-economic changes at the national and international levels on the firm’s stability. This also helps in development of action plans to deal with the technological advancements. 

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