Basic Economic Questions and Systems

Economics is the study of how people make choices in the face of scarcity. Human beings have more needs and wants than there are resources available to fulfill those needs and wants. Therefore, humans must make decisions about what they will produce, what they will consume, and how they will distribute what they produce. The most heated debates in government and in society focus on the economy. When you turn on the television or read a newspaper, politicians are constantly discussing the need to boost the economy and often make the economy one of the primary focuses of their campaigns.

The way a nation is governed impacts many of the decisions it makes about the economy. There are three basic economic questions that every society must answer:

1. What goods and services will be produced?

2. How will these goods and services be produced?

3. Who will consume these goods and services?

Economic Systems

How different nations answer these questions determines the type of economic system they have. The types of economic systems are outlined as follows:

• A traditional economy answers these questions the same way it has always answered them. It is a system that depends on the customs and traditions of the people involved. These customs shape the types of goods and services produced. A traditional economy usually focuses on agriculture, fishing, and hunting. Geographic areas associated with a traditional economy are Asia, Africa, the Middle East, and Latin America.

• In a free-market economy, individual producers and consumers answer the basic economic questions. It is a system that focuses on supply and demand with little or no government intervention. The consumer drives demand, and private companies supply goods. Prices and wages are determined by interactions between producers and consumers in the marketplace and are heavily impacted by competition.

• In a command economy, the government answers the basic economic questions. It is a system that allows a central authority, typically the government, to make all of the economic decisions. The government usually owns the land and the means of producing goods. This system is commonly found within communist governments.

• A mixed economy lies somewhere on the wide spectrum between a free-market economy and a command economy. Most nations in the world operate using a mixed economy. For example, the United States is a mixed economy. It is closer to being a free-market economy than a command economy, but it is not a pure free-market economy because the government gets involved in some of the economic decision-making.

Adam Smith

Karl Marx

The free-market economy and the command economy are the two systems with the greatest contrast. Adam Smith, author of The Wealth of Nations, was a promoter of the free-market economic system. Smith believed that a nation's wealth is determined by the goods and services that it creates. He promoted the idea that supply and demand drive price and competition, and that free exchange is healthy for an economy. Another component of a free-market or free-enterprise economy is the need for specialization of a labor force. Karl Marx, author of The Communist Manifesto, was the father of communism. Marx promoted the idea that the government should control and decide on the production and distribution of goods and services. He believed that everyone should have common ownership and receive a fair share.

Economic Freedom

There is an obvious connection between the freedom of a country's citizens and its economy. Democratic nations have a high degree of both political and economic freedom, while authoritarian nations have a low degree of political and economic freedom. Historically, countries in which citizens have limited political and economic freedom have suffered economic woes. For example, the citizens of Cuba have long suffered extreme poverty because of their inability to participate in the political process. With the introduction of Fidel Castro as leader of Cuba in 1959, elections stopped. As a result, the buildings, roads, bridges, and general infrastructure of Cuba crumbled. The citizens were not able to prosper, and many of the goods that were needed became unattainable because of the poor relationship between Cuba and other countries. Cuba was able to maintain a good relationship with the former Soviet Union; however, this did not prove particularly beneficial as the Soviet Union was also experiencing a lack of prosperity. The example of Cuba demonstrates that government officials, citizens, and the economy are significantly intertwined. Free people benefit from a free-market economy, one in which the citizens make the decisions for themselves.

The basis of a free-market economic system is the freedom of individuals to make the economic choices that they want. An important role of government is to protect these freedoms. Such economic freedoms include being able to earn money, own property, buy goods and services, choose your own career, choose where and how much to save, start new businesses, and decide what to produce.

These freedoms are important, but sometimes people can be harmed by bad actors. That's where the government can step in and act as an economic referee. The American government has passed laws and created several agencies to help protect consumers and workers.