An economic system is “the way in which a country’s economy is organised.” (Le Roux, 1995, pg 8).
There are many different economic systems in place around the world, and each system has different ways of solving economic problems such as the distribution of scarce resources. At one end of the economic system is the Communist Economic System, where the government takes control of economic problems.
On the other end of the system is the Capitalist Economic System, where the economy is market-oriented and allows market forces to determine solutions to economic problems. These solutions are usually derived from forces of demand and supply. This is also known as a free-market system.
Communism
The idea behind communism lies in all assets belonging to the population. This system is controlled by the state and the consumer plays no role of importance in this system at all. Market mechanisms of demand and supply are virtually non-existent in this system, as the state decides what and how much should be produced.
Advantages of communism:
- Income is distributed more equally than in a free-market system.
- Due to the fact that the state controls the sharing of the economy, fluctuations are mostly eliminated.
Disadvantages of communism:
- It is difficult to obtain internal balances of supply and demand without using the pricing mechanism.
- It is difficult to implement.
- Consumer’s needs are not considered.
- Freedom is restricted.
- Maximum productivity is undermined.
The Free-market System
In this system, factors of production (such as land, labour, capital and entrepreneur-ship) are owned by private individuals. The forces of demand and supply determine how resources are allocated without any government intervention.
In the market place, there are a large number of different buyers and sellers, thus creating competition that allows for changes in demand and supply. With so many varieties and substitutes, if one product becomes too expensive, a cheaper substitute can be chosen. This also allows equal ability for suppliers and consumers to influence price.
The competitive environment, in which these buyers and sellers operate, is known as the market structure. There are four types of market structure.
- Perfect Competition has a large number of buyers and sellers that make decisions and do not take the effect of their actions into account. This is due to the fact that individual economic units in perfect competition are small and are unrelated to other economic units. Their actions have no impact on other buyers and sellers.
- Monopoly is where a single organisation sells a product or service, but has no close substitutes. There is virtually no competition; however entry into this market is very difficult, almost impossible.
- Monopolistic Competition has many sellers of a differentiated product or service. Entry is easy in the long-run.
- Oligopoly has a few sellers of a differentiated product or service, or a homogenous good. Entry into this market is not very easy, but is possible.
Monopoly, monopolistic competition and oligopoly are forms of imperfect competition, which exists due to the fact that entry into these markets is not necessarily easy. Few firms and businesses
operate in these markets in order to gain maxi-mum control over the price of their goods and services. Consumers have little influence on the price of goods and services.
Perfect competition
Perfect competition has many buyers and sellers that are too small to affect the price of a product or service. The product is usually homogenous and consumers use the price to help them decide
whether to purchase. Resources are perfectly mobile and there is perfect general knowledge of the market conditions.
Perfect competition means that businesses and consumers will only exchange products and services if they both benefit from the trade. Voluntary exchange is maximized under perfect competition as
output is increased until no consumers are willing to pay the opportunity cost of producing additional units of product or service. Resources are allocated efficiently to ensure that capital is
being used at its highest value. For example, if the return in a competitive sector earns less than the normal rate, resources will leave the sector and be re-distributed until the remaining resources earn the normal rate of return again.
In perfect competition, production occurs at a minimum cost but this does not mean that it is more efficient than other market systems.
Why do businesses operate in competitive markets and how does this benefit consumers and the economy?
The labour government of South Africa deems competition as being beneficial for the economy as it is the main force behind productivity growth in the economy, and it encourages businesses to reduce slack and costs while providing incentives for more efficient production. Competition also helps consumers to get lower prices as well as a greater variety of products and services.
Improvements to quality and customer service are also gains from market competition, as well as allowing consumers to make better informed choices. Using the knowledge you have gained on
demand and supply from the previous chapter, as well as the knowledge from this chapter on competitive markets and economic system, you should be well on your way to grasping the basic
concepts of economics.
Varying prices of the same product/service illustrating competition
The same product cost different amounts in different places. Take a 1 kg box of branded soap powder.
At a large chain store in the city it may cost R 20. At the cafe around the comer the same pack may cost R 23-00 while at the 24-hour convenient store it will be R 28-00, while at the spaza store down
the road it may be R25-00. Oh yes, and at Makro it may cost R 17-00 a pack, but then you have to take four! Each of the shops has a unique competitive advantage, which ensures that the price asked
is the most optimal for that particular market. If the above prices were the actual prevailing prices over a given period, can you think what would happen if anyone of them would double their prices?
Yes, people would buy the product at the other outlets. Relatively small (but significant) differences will be tolerated by consumers, but outside a given range they will switch to another shop.
Competition ensures that prices stay within a given range.
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