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Determinants of an Economic System
Key Terms
1. Economic system: A way in which a nation uses its resources to satisfy people’s needs and
wants for goods and services. The way in which a society decides what goods and services to
produce, how to produce and distribute them, and for whom they will be produced.
2. Traditional economy: A system in which economic decisions are based on customs and beliefs
that have been handed down from generation to generation. Traditional economies look to the
past to answer the questions of: What to produce? How to produce? For whom to produce?
3. Command economy: A system in which government controls the factor of production and
makes all decisions about their use.
4. Market economy: A system in which individuals own the factors of production and make
economic decisions through free interactions while looking out for their own self-interests or
best interests. An economy in which all decisions on the allocation of resources is made through
decentralized decisions of many firms and households as they interact in markets for goods and
services.
5. Mixed economy: A system combining the characteristics of more than one type of economy. In
reality, all economies are mixed economies.
6. Authoritarian socialism (communism): The economic system where government owns or
controls nearly all the factors of production. Authoritarian socialism or communism is the
economic system that is nearest to a pure command model.
7. Democratic socialism: The economic system where the government owns some of the factors of
production. Individuals also own some of the factors of production and are able to influence
economic planning through the election of government officials.
8. Capitalism: The economic system where individuals own most of the factors of production and
answer the basic economic questions (What to produce? How to produce? For whom to
produce?) Capitalism is the economic system that is nearest to a pure market model.
9. Free enterprise (capitalism): The economic system under which business can be conducted
freely with little government intervention. Individuals own most the resources and control their
use. Individuals own the factors of production and decide how to use them within legal limits.
10. Laissez-faire economics: An economic system in which the government minimizes its
interference in the economy. A hands-off approach to economic activity.
11. Socialism: An economic system in which government owns and controls many of the resources.
12. Economic efficiency: Wise use of available resources so that costs (opportunity costs) do not
exceed benefits. Getting the most it can from its scarce resources. Capitalism is more
concerned with economic efficiency.
13. Economic Equity: The attempt to balance an economic policy so that everyone benefits fairly.
Distributing economic prosperity fairly among members of society. Socialism is more concerned
with economic equity.
14. Standard of living: The material well-being of an individual, group, or nation measured by how
well their needs and wants are satisfied. Standard of living is determined by how many goods
and services are produced by a nation. The dollar value of these goods and services produced is
divided by the population of a nation to determine the per-capita standard of living (GDP). A
capitalist nation is concerned with achieving the highest per-capita standard of living (GDP).
15. Income distribution: The way all the income earned in a country is divided among different
groups of income earners. Socialist nations are concerned with achieving a fair or equal
distribution of income.
Questions
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What are the three economic questions that every society must answer?
List three ways in which capitalism and socialism are different?
How is the question (for whom are goods produced) answered in a free enterprise economy.
How does a traditional economy answer the question (how should it be produced)?
Who answer the three basic economic questions in a command system?
Who owns the factors of production in a market economy?
How do traditional and command economies differ?
Who answers the three basic questions in a market economy?
Why are self-interest and incentives important in a market economy?
Describe the extent of government involvement in command, traditional, and market
economies.
11. Why is it said that all economies in today’s world are mixed economies?
12. Describe how the U.S. market economy is a mixed economy or has characteristics of all three
economic systems.