Market Equilibrium and Various Economic Systems

Where demand meets supply

We have discussed the features of demand and the supply curves in earlier sections. When the supply curve meets the demand curve, it gives us an equilibrium price and quantity.

  • There is excess supply when prices are above the equilibrium price (PE = $5). The effect of excess supply will force the the market price to go down.
  • There is excess demand when prices are below the equilibrium (PE = $5). The excess demand creates shortages and forces the price to go up.
  • When the amount that consumers want to buy is exactly equal to the amount that producers are prepared to sell, it will give us a stable sweet spot. This is the equilibrium market price, and quantity. In the diagram, the quantity demanded is equal to quantity supplied (which is at QE=8), while the equilibrium price is PE=$5.
equilibrium-market equilibrium - demand meets supply-free market economy - market economy - market price and market quantity

Three fundamental questions of economics

Economics is the study of the science that deals with the production, distribution, and consumption of goods and services. Economists are interested to answer three fundamental economic questions which are:

  1. What to produce?
  2. How to produce?
  3. For whom are these goods and services produced? 

We can broadly classify societies into three categories based on how they answer these three fundamental economic questions.

Three types of economic systems

1. Market Economy

A society can organise itself around allowing market forces of supply and demand to answer the three fundamental questions. Such a society is known as “Market Economy“. They are sometimes called “Free Market Economy” or “Capitalist System”.

A market economy has the following characteristics:

#1 No government intervention

  • The government does not intervene in the economic activities of the economy. All economic decisions and activities are carried out by the private sector.

#2 Consumer sovereignty

  • Consumers determine what goods are produced. They signal this by their willingness to pay a price of the goods they want. They influence the producers in deciding what goods to produce.

#3 Mobility of labour

  • A market system has geographical and occupational mobility.
  • Geographical mobility means that people looking for jobs are able to move across the country or to different countries depending on whether jobs are available.
  • Occupational mobility means that people looking for jobs are able to freely move across different industries and job roles to find work.
  • These mobility brings about the efficient use of labour and this in turn increases productivity.

#4 Strong presence of competition, and companies are profit driven

  • Businesses compete with each other and try to maximise their own profit. In the process, these business are constantly searching for the best and least cost use of economic resources. 

#5 High income disparity

  • The market system does not guarantee that everyone gets and consumes the goods and services fairly. For instance, the economically less well off are often not able to consume certain goods and services that they need. 
  • In a ‘pure’ market economy where the government fully subscribes to the policy of non-intervention, the rich can become richer while the poor become poorer.
  • A wide gap often exists between the rich and the poor, leading to a huge disparity in the economy.

2. Command Economy

While the “market economy” has many desirable qualities. But there are also downsides, such as high income equality. This, in turn, can affect what goods they can consume or not. For instance, consumers who are earn less are not be able to afford certain “desirable” goods such as equality education and affordable housing.

The “Command Economy” is an alternative approach to answer the three fundamental economic question. This is also known as “Centrally Planned Economy”, or simply “Planned Economy”. The command economy can be further sub-divided into “Socialist Economy” and “Communist Economy”.

In this approach, the government controls every aspect of economic decision making. In other words, the government owns these resources and they decide how these resources should be used. In addition, the government also decides on how to distribute the goods and services. This central authority, therefore, decides what, how and for whom goods and services should be produced. 

A command economy has the following characteristics:

#1 Resources are government controlled

  • The government determines all resource allocation. It plans the output of each industry and firm, what techniques to use and how much manpower and raw materials to use.
  • Often, the government is not able to allocate the resources sufficiently in some key areas such as R&D and quality education. 
  • In addition, resources are often over-allocation in certain areas such as military and surveillance technology that may not be in the best interests of its citizens.

#2 No consumer sovereignty

  • Consumers do not have choices but have to accept all the decisions of the central authorities as to what they should consume.
  • The price mechanism is not relevant in such an economy. The government would plan the distribution of output among the consumers. 
  • The government distributes goods based on their judgment of people’s needs. Often, they may give more to those who produce more. It is difficult to assess the wants of the consumers This leads to miscalculation on how much of goods and services to produce, as well as how to distribute them fairly.

#3 Unemployment does not exist

  • Theoretically, unemployment does not exist in a command economy, because every worker available will be given a job by the government. 
  • This does not mean, however, that the job allocated is good or suitable for everyone.
  • Additionally, there are no guarantees that all labour resources will be used fully or efficiently.  For instance, workers may be given a job in a factory that may already has too many people. 

#4 Minimal income disparity

  • A command economy aims to achieve the following goals of economic equity, stability, and security. 
  • Wealth is shared equally, and all the factors of production would be controlled collectively.

3. Mixed Economy

In reality, most economies are actually a blend of both market and command economies. In other words, most economies are actually a “Mixed Economy“. In a mixed economy, some parts of the economy are left to private ownership, while other areas have a larger degree of government intervention.

A mixed economy has the following characteristics:

#1 Presence of both Centrally-owned Enterprises as well as Private-owned Enterprises

  • Private sector produces most goods and services. They determine what goods to produce, and how much to produce.
  • The government takes over the production of certain goods and services where it is not profitable for private sector to produce them. Examples include:
  • (a) low-cost public housing,
  • (b) affordable healthcare,
  • (c) quality education, and
  • (b) public transportation system.

#2 Government intervenes only when necessary

  • Private sector alone is not able to produce certain goods and services in a manner that maximises welfare of all in the market.
  • In such instances, the government takes over – either producing these goods and services themselves, or imposing regulations on the producers.
  • For instance, the government oversees the construction of key infrastructure, operating the military, and overseeing law and order.
  • The government may also enact legislation to police unhealthy monopoly behaviour in the economy.

#3 Some complements of private and public sector

  • The public sector does not compete with the private sector but to complement it by providing the infrastructure. This is so that economic activities can be carried out effectively and efficiently.

#4 Presence of income disparity

  •  It is difficult to eradicate income inequality.
  • In a lot of mixed economies, the income inequality can be very high despite best efforts by the government.