The economic system consists of: consumers, producers, government and industrial organizations

 

• Each and every system purchases goods and services in order to satisfy human needs
• There is a coordination mechanism among these sectors
• It has developed various conventions, traditions, laws and regulations and norms for the function of the mechanism.
• Some sectors control the other sectors in order to maintain the sustainability of the mechanism

A few shapes could be found in the coordinating mechanism as follows 

• Traditions
• Price Mechanism
• Command / Planning mechanism
• When allocating scare resource answer the basic economic problems: what to produce in what quantity, how to produce and for whom to produce by the coordinating mechanism
• The price mechanism provides answers to the basic economic problems based on the profit and the price signal of the goods market and the factor market
• The planning mechanism provides answers to the basic economic problems concerning the common welfare in general

 

The laws and regulations mentioned below exist in each and every economic system in order to strengthen the economic process

• Legal framework
• Here, freedom of property, freedom of entrepreneur, freedom of choice are
  specially important.
• Process
• Policies Here economic policies and social policies are important
• Norms and traditions
• Habits and culture

Any society face basic economic problem generally.
• Different economic systems occur as the result of solving these basic economic problem.
• These economic systems can be categorized as Market economy, Command economy and Mixed economy.
• Market economy is termed as a Capitalist economic system or a Free enterprise economic system, alternatively.

 

The main characteristics of a Market economy can be explained as follows

 

• Private ownership of property
• Free enterprise and freedom of choice
• Competition and free market
•  Function of a price mechanism
• Self interest and profits
• limited role of the government
• A price mechanism functions as the coordinating mechanism of solving basic economic problems in the market economy.
• The basic economic problems of what and how much to produce is solved in the Market economy by the price signals of the good market.
• The basic economic problem of how to produce is solved in the market economy by the signals of the factor market.
• In the market economy , individual income is decided by two factors such as , price of factors of production in the factor market and exchange of quantity for the price
• The price mechanism does the following functions in the market economy
• Signaling function
• Incentive function
• Allocation function

There are some disadvantage also in the market economy such as,

• Inefficient allocation of resources.
• Failure to provide public goods and merit goods.
• Externalities.
• Occurrence of economic disparities.

Command economic system is explained as an economy where the basic economic questions are solved by the centrally planned authority.
The main characteristics of a Command economic system can be explained as 

• Government owns all the factors of production except labour.
• Basic economic problems are solved by a centrally planed authority under
  the guidance of the government.
• Competition and free market
• Function on social welfare
• A centrally planned authority decides on what and how much to produce andinforms production units.
• A centrally planned authority decides on how to produce. production units are the
  government entrepreneurship and incentives are decides according to the orders of a centrally planed authority.
• For whom to produced is decided according to the price of factors of production
• Because of the disadvantages of Command economic systems, these economic systems have been transited to Market economy.Examples: Russia, China and eastern European countries
• Most characteristics of Command economic system and Market economic systems are mixed up and mixed economies occur in most countries
  Example: Sri Lanka, India and Pakistan

The Following characteristics can be seen in a Mixed economic system.

• Public ownership of property
• Private freedom limited.
• The decisions regarding allocating resources of society is taken by the
  government or is centrally planed by authority.

A society faces the following common and basic economic problems.  What is produced in what quantity? – Problem on resource allocation

• How to produce? -problem on technology use
• For whom to produce? – Problem on how to distribute production
• Basic economic problems arise due to limited resources, alternative uses of resources
  and unlimited human wants

Basic economic problem of What to produce in what quantity, arises due to the following reasons

• Available resources are limited
• Resources have alternative uses
• Human wants are unlimited

Two types of main technology could be identified when we find solutions to the basiceconomic problem of How to produce?

• Labor intensive technology
• Capital intensive technology

Basic economic problem of What to produce in what quantity arises due to the following reasons

• Available resources are limited
• Resources have alternative uses
• Human wants are unlimited

Two types of main technology could be identified when we find the solution to the basic economic problem of How to produce?

• Labor intensive technology
• Capital intensive technology

The basic economic problem of How to produce? arises due to the following reasons

• Alternative combinations of factors of production
• Change in comparative cost
• Limited resources

The basic economic problem, “for whom to produce?” arises due to the following reasons

• Limitation of the quantity of goods produced
• Change of personal purchasing power

Even though the basic economic problems are common for all the method used to solve the problem differs from society to society

When there is full and efficient utilization of resources production combination lies on the boundary of the Production Possibility Curve.

• When there is under and inefficient utilization of resources, production combination
  lies on the left side of the Production Possibility Curve.
• Scarcity can be shown by a point on the right hand side of the Production Possibility
  Curve.
• The point which moves from the left side to the Production Possibility Curve, can
  increase production of both goods without opportunity cost
• The point which moves from the Production Possibility Curve to the left, shows
  decrease utilization of resources and efficiently.
• Production Possibility Curve can be shifted to the right due to the increase in
  capacity of production

The factors of increase in capacity of production are given below.

• Increase in factor endowments.
• Increase in productivity.
• Production Possibility Curve can be shifted to left side due to the decrease in the
  capacity of production

The factors of decrease in capacity of production are given below.

• Decrease in factor endowments.
• Decrease in productivity.
• Outputs received from the inputs are known as normal productivity

The following factors affect determination of productivity of the factors of production

• Technology
• Management
• Human Capital
• Division of labor and specialization

 

• Factor productivity can be computed as follows :
  Factors Productivity = Outputs / Inputs

 

• Productivity of the various factors of production can be computed as follows:
  Productivity of Land = Total output / Amount of land units

Food, clothes , houses ,education and health are the basic human needs.
Various ways used to satisfy the basic needs are known as wants.

• Needs are limited and wants are unlimited.
• Needs are common and wants vary from person to person.
• Needs are biological and wants are related to social and cultural factors.
  As mentioned below ,there are two types of goods which can satisfy human
  needs.
•  Free goods ( non economic goods)
•  Economic goods
• The following characteristics could be highlighted in non economics goods
• There are no cost of resources and opportunity cost
• Unlimited receipt from nature under zero price
• The following characteristics could be found in economic goods
• Cost of resources and opportunity cost exist.
• Produced by the man combining productions factors.
• Even if a non economic good is obtained by incurring factor cost, it becomes an
  economic good.

All inputs used for the production process are considered as resources.

• Scare resources used to produce goods and services incurring costs are known as
  economic resources.
• The resources used to produce goods and services, freely available in nature, which
  do not incurr opportunity cost and scarcity are called non economic resources.

Factors of production can be categorized mainly into four, as given below

•  Land
•  Labor
• Capital
• Entrepreneurship

All the resources gifted by nature, which can be used for production and have productivity are called land.

 

A few characteristics of this can be summarized as follows

• It is a natural resource
• Supply is inelastic
• Limitations of mobility present
• Productivity can be increased
• Payment for land is rent.

Physical and mental effort used for the production of goods and services are called labour

A few characteristics of labor are mentioned below

• Live factor of production
• Movable
• Heterogeneous
• Labor productivity could be developed
• Labor cannot be separated from the laborer
• Wage is the payment for labor

The number of labor hours employed during a certain period for the production of goods and services are called supply of labor

• Labor supply is determined by the factors mentioned below
• Labor force
• Number of working hours
• Wage level

 

Human creations used in the production of goods and services are known as capital

A few characteristic of capital are mentioned below

• Human created factor
• Exists to ensure productivity
• Repetitively used for production.
• Depreciation a necessary factor
• Payment for the capital is known as interest

 

Capital can be categorize in the following way

• Fixed /real capital
• Circulation capital / working capital
• Economic overhead capital
• Natural capital
• Social capital

 

There is a relationship between the savings investment and capital stock The process of taking production decisions, organizing production activities and monitoring while bearing a risk is known as entrepreneurship

The role performed by an entrepreneur can be summarized as follows

• Taking policy decisions
• Organizing production activities
• Monitoring production activities
• Innovations
• Bearing risks

The following characteristics exist in entrepreneurship

• Human factor
• Initiative ness
• Leadership qualities
• Ability to face challenges effectively
• Futuristic
• Self confidence
• Can be trained

• Resources are limited and they have alternative uses
• Since scarce resources have alternative uses, there is need to choose one
  alternative.

When a choice is made from among the alternatives the cost of next best
alternative is identified as the opportunity cost

• Opportunity cost is a real concept