Any economic activity needs resources, and the functions of an economic system revolve around decisions pertaining to their creation and allocation.
An economic system is a system of production, allocation, and consumption of resources. The four different types of economic systems are traditional, command, market, and mixed. Be it any type of economy, its functions pertain to taking decisions regarding the optimum utilization of the available resources.
An economic system needs to formulate a matrix that will ensure optimum utilization of its resources, minimal wastage, and a proper distribution of resources. Depending on the type of the economic system, the decisions it takes and the parameters based on which they are taken, differ.
Let's delve deeper into understanding what decisions are taken by an economic system and how. Following are the four main functions of economic systems.
What to Produce
This is the most basic question every economy has to answer, depending on what it wants to use its resources for. It needs to consider the opportunity cost for what it is not producing. In this era of globalization, countries may decide to specialize and import the required products and services, instead of using all the resources for producing on their own. Production decisions also depend on the resources available, climatic conditions, government regulations, preferences of the consumers, etc.
How Much to Produce
How much to produce for it to be sufficient for everyone, is an important question an economic system has to answer. This needs to be done considering the availability of resources and the constraints (if any), while also ensuring minimal wastage of resources. Whether all the resources should be utilized, or some should be kept idle for future use, is another consideration to make. For example, when the depletion of fossil fuels all over the world indicates an overuse of this resource, an economic system should work towards reducing its use, possibly by creating alternatives.
How to Produce
Whether to adopt technology or use traditional methods of production is the decision of the economy. Technology may lead to reduced costs with more efficiency. However, if labor is available in abundance, it is preferable to use labor-intensive techniques. Thus, a cost-effective plan should be made while planning how to produce.
For Whom to Produce
This includes functions related to the distribution and allocation of resources. The purchasing capacity of individuals determines the distribution of resources. Ideally, there should be a fair distribution of resources among all individuals that are a part of the economic system. However, it is not possible for all the individuals to get an equal share in the resources. And that is due to economic differences. Hence, in real-life, individuals compete with each other for a higher purchasing capacity.
Along with taking decisions pertaining to these four areas, economic systems have to ensure the economic stability and growth of the economy. Checking on inflation, taking financial decisions, determining the EXIM (Export-Import) policies, ensuring that the resources are not exhausted, implementation of new technology, etc., are the allied activities that come with the four basic decisions that economic systems have to take.
Types of Economic Systems and their Functions
An economic system should plan for the economic growth of the nation, along with optimum utilization of resources and factors of production. Different economic systems have different approaches to answering this question.
◾ In a free market economy, the demand and supply forces decide everything. However, there might be instances of wealth and resources accumulated in the hands of a select few in this economic system.
◾ On the other hand, a traditional economy takes all its decisions based on customs and traditions and long-followed practices. Such economies may majorly concentrate on farming and traditional techniques of production.
◾ In a command economy, the government takes all the decisions, and no private forces are allowed to intervene.
◾ A more real-life economic system is a mixed economy, wherein many areas are ruled by private factors with some degree of government regulation. Of course, considering the best interests of the nation, there might be government monopoly in some sectors to avoid the misuse of resources, and to ensure fair distribution. However, privatization is on the rise. For example, the energy sector was deregulated in a few states in the U.S.
Well, there cannot be any foolproof model that has an answer to the question of the scarcity of resources. Every economic system has to tackle this problem in its own way, depending on factors like population, the resources available, climate, geographical area, relations with foreign countries, import-export policies, etc.