Introduction to Economics and Economic Systems
Mustapha Muktar, Ph.D
Department of Economics
Bayero University, Kano-Nigeria
Introduction
Adam smith defined the subject matter of economics as the study of the causes of material welfare or as the science of wealth. Alfred Marshall in particular defined economics as the study of production, consumption, exchange and distribution of wealth by men engage in the ordinary business of life. Robinson however defined this subject matter as too restricted in scope to embrace all the facts. According to Robinson "Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses". A satisfactory definition must combine both these conception of economics. We may define economics as social science concerned with the proper use and allocation of scarce resources for the achievement and maintenance of growth and stability.
Basic Concepts of Economics
Basically there are 6 basic concepts of economics. These are:
1) Ends/wants: These are goods and services, which are desired for consumption. Goods include things like foods, houses, books, etc. while services hairdressing the service of an actor etc.
2) Means/Resources. These refer to basic instruments with which human wants can be satisfied. Resources include the productive resources such as lands labour, capital and entrepreneur, which are used in production of goods and services, in short human ends/wants are many and the resources to satisfy them are limited/ scarce
3) Scarcity. This is the fundamental or basic economic problem. Human wants/ends are unlimited as a result of scarcity of resources. In other word scarcity refers to the inability of human beings to provide themselves with all things. However, economic goods are scarce (Limited in supply) in relating alternatives. This scarcity is the root of economics.
4} Choice this refers to distribution of our scarce resources among different economic ends. When we have chosen or selected one thing we have to sacrifice some other things because our resources may not be sufficient to satisfy both at the same time. Thus choice arises because of scarcity of resources.
5) Scale of preference. In order to achieve maximum satisfaction with limited resources at disposal, individual, firm, and government arrange their unlimited wants in order of relative importance and this is called a scale of preference. Thus, different economic agents make efficient use of scarce resources to meet up their numerous wants or production needs as a result of arrangement of their wants in order of preference. Therefore, the agents choose those that give the highest utility.
6) Opportunity cost. This is the forgone alternative. The concept of opportunity cost i.e. (real cost) which is the alternative forgone when resources are directed to the satisfaction of one wants rather than the next alternative uses.
Why the Study of Economics is Important
(i) The study of economics is important because it teaches us how to make rational use of scarce resources to satisfy our unlimited wants.
(ii) It offers the firm and the government a rational guide in the allocation of scarce resources.
(iii) It enables the government to plan towards national integration and economic growth.
(iv) In choice making it helps us arrange our needs in order of preference.
(v) The study of economics helps us to solve the problems of what to produce, how to produce and for whom to produce.
(vi) It helps us to offer economic solution to economic problems.
(vii) It equips one to be in a better position to estimate a country's total wealth.
(viii) It helps the individual to build up a body of economic principles and equips him with the tools of economic analysis.
Economics as a Social Science
Economic is a science and indeed a social science. The functions of science is to establish general laws covering the behaviour of the empirical objects/events with which the science in question is concerned, and thereby enable us to collect and gather our knowledge of separately known events and to make reliable prediction of event as yet unknown. These concern a theory. A theory is a set of concepts, definitions, and prepositions that presents among variable with the purpose of explaining and predicting A phenomenon. In short theory represents implication and generalization of reality and therefore do not completely describe a particular situation. Economics as a social science studies human behaviour in relation to his economic activities: It is concerned with the behavior of people in relation to production, distribution and utilization of wealth while physical or natural sciences studies living and non-living things and its environment. In a nutshell, economics as social science studies and deals with human behavior relative to their resources while physical or natural sciences deal with human beings and objects that are subjects to laboratory experiment. In the study of both economics and physical sciences. The same methodology is used in conducting a research: -
1) Observations of phenomenon
2. Collection and recording of observation
3. Analysis of recorded observation
4. Classification of recorded observation.
5. Conclusion and prediction from the result of the observation
6. A test of the result against reality
7. Confirmation or rejection of the results of the laws of economics, which is dynamic i.e. subject to change by individual consumer.
Nature of Economic Problems
The main problem of an economy is that of economizing resources: in this sense economics is the study of the allocation of scarce resources and alternative ends. In other words the fundamental problem of economics is scarcity. Human wants are unlimited and the means to satisfy them are scarce and limited. Thus, economics is concerned with problem of using resources to meet the unlimited wants of human beings. The solution to these problems of allocation scarce resources lies in the price system, which exists in every economic system whether it is capitalism, socialism or mixed economy. In an effort to solve these problems an economist is pre-occupied with the following different questions:
What to Produce and in What Quantity: The first central problem of an economy is to decide what goods and services are to be produced and in what quantity. This involves the allocating of scarce resources in relation to the composition of total output in the economy. Since the resources are scarce, society has to decide on the goods to be produced.
How to Produce: The next problem of an economist is to decide on how to produce goods and services with what combinations and what method of production. This method is primarily dependent upon the available resources within the economy. Further, goods and services can be produced with different combinations of factors of production. If land is available in abundance it may have extensive cultivation. But if land is scarce, intensive method of cultivation may be used. If labour is in abundance it may be labour intensive techniques while in the case of labour shortage, capital-intensive technique may be used.
For Whom to Produce: This is the allocation of goods among the members of the society. How should the consumer goods be distributed? How should the capital goods be distributed? The allocation of consumer goods among the household takes place on the basis of exchange whoever possess the means to buy the good may have it.
How Efficient are the Resources Being Utilized: Society has to see whether the resources it owns are being utilized fully or not. In case the resources of the economy are lying idle. It has to find out ways and means to utilize them fully. If idleness of resources (Manpower. Land and capital) is due to their misallocation, the society will have to adopt such monetary, fiscal or physical policies or measures so that it can be corrected. In an economy where the available resources are being fully utilized. It is characterized by technical efficiency or full employment. To maintain it at his level, the economy must always be increasing the output of some goods and services by giving up something to others.
Is the Economy Growing or is Stagnant: The most important problem is to find out whether the resources of the economy are growing, does it accelerates through a high rate of capital formation? which consist of replacing existing capital goods with new and more productive ones, by adopting more efficient production method, or through innovation.
Economic System
The term economic system refers to the mode of production and distribution of goods and services within which economic activities takes place. In other words, "Assar Ling back" defined it as "a set of mechanism and institution for decision making concerning production, distribution and consumption within a given geographical area" in a broader sense, the term economic system also refers to how different economic agents solve the central problems of economy what, how and for whom to produce. Basically, there are characteristic/features, which are very crucial in differentiating economic system. They are: -
1) Organization of decision making arrangements
2) Mechanism for the provision of information and coordinating market and plans.
3) Property right, ownership and control.
4) Mechanism for setting goals and inducing to act (incentives)
One of the major characteristics, which distinguish different economic system is thus, the organization or decision-making arrangement for example, such a decision may concern the allocation of resources in national economy, in comparing economics system. The question could be asked to what extent are allocation decision administered by central authority or taken by the micro-units (either households or firm) independently or state authority here refers to the allocation or input to different sectors or economy for production and distribution or output to final consumers. The level of decision-making also depends on the handling of information. And the relevant information is in the hands of the central authority or possessed by different sub-unit.
Economic systems could also be distinguished through the mechanism by which information about the decision process and coordinating passed to the sub-unit. These could be market or planning. The term "Planning" has a very broad meaning in a book called DAS CAPITAL as the system of managing economic process involving production, distribution, investment and consumption" in essence, it consists of determining economic target and method for their implementation, in particular the allocation of the means of production and of economic strategies achieve optimum growth of national income or the maximum satisfaction of social means. In a planned economy sub-units, individual and firms are co-coordinated largely by the specific institution or determined by the cultural or by disseminated information called a plan. But in free market economy the impact of the interaction of the invisible forces of demand and supply can provide information on price signals that can enhance sub-unit in the system to make resources utilization, decision and the market to coordinate the activities of different decision making unit. For example household earns income by providing land, labour and capital to the system and with this income profit could be generated.
Property ownership also serves as a distinguishing feature of economic system, ownership right falls under three broad types or categories. These are: -
Disposition right; this is the ability to dispose any property owned by individuals, firms or government either by transfer, selling or otherwise. Utilization right; this is the ability to use the property as deemed fit. Exploration right; It is the right to use the products or services generated by the property in question. In a nutshell, there are 3 forms of property ownership namely, private, public and collective. They relate closely to the way in which we classify different economic system for example if private ownership prevails, each of the 3 ownership rights will belong to individual whereas under public ownership these 3 property ownership rights will belong typically to the state.
Incentives mechanism should induce participants at lower level to fulfill the directives of participants at higher-level. Incentives can be material or moral. Material incentives on one hand consist of a system of reward that promote desirable behavior by giving recipient a greater claim over material goods than one who has performed less work. Moral incentives on the other hand revolve around rewarding desirable behavior by appealing to the recipient social stature within the community without giving him or her command over material goods.
Types of Economic System
Capitalism
It is an economic system in which individual in his capacity as a consumer, producer and resources owner is engaged in economic activities with substantial economic freedom. Individuals economic action conform to the existing legal and institutional framework of the society which is governed by the institution of private property, profit motive, freedom of enterprises and consumer sovereignty under such an economic system, all factors of production are privately owned and managed by individuals.
Features of Capitalism
The following features characterize the capitalist economy otherwise known as market economy or free enterprise: -
1) Private property: it is freedom of individual as consumer or producer to own property or means of production as use them the way he likes but not in such a way to endanger society.
2) Profit motive: The main motive behind capitalist economic system is to maximize profit
3) Price mechanism: prices of all goods and services as well as indivisible hands determine factor inputs.
4) Role of the state: in capitalism economic system government's major role includes the provision the institutional and legal framework to ease working of economy and the provision of public goods and the regulation of monopolies.
5) Consumer's sovereignty: in capitalist economic system consumer is king. He has power to make choice. Thus consumers buy whatever they feel like and work wherever their feel like without any restriction.
6) Freedom of enterprise: Under the system, private individuals are free to engage in any economic activity they wish, provided they have enough capital to do so. There is no restriction as far as enterprise is concerned; individual can be producer, farmer mechanic, plumber etc.
7) Competition: In capitalist economic system there is freedom of exit and entry into business activities and thus enterprises are price taker and as such there is no monopoly situation under the system.
Advantages of Capitalism
1) Increase in production: This leads to the rise of income, saving investment and progress where every farmer, trader and industrialist can hold property and use it in the way he likes. This brings about improvement in production and increased productivity.
2) Quality product at low cost: The twin freedom of consumer and producer leads to the production of quality product and lowering cost and prices.
3) Optimum use of resources: Under capitalism producers undertakes the production of only those goods appear to yield maximum profit in anticipation of demand.
4) Flexible system. In capitalist economy operates automatically through the price mechanism.
5) Efficiency: The presence of competition under capitalism leads to increase efficiency, encourage innovation, research and specialization thereby bringing progress and prosperity in the country.
Disadvantages of Capitalism
1) It leads to monopoly in the Long run: Competition which is one of important feature of capitalism turn out monopoly situation in Long run because less powerful enterprises are forced out of industry and hence monopoly.
2) Income inequality: institution of private property creates inequalities of income and wealth under capitalism.
3) Inefficient production. Capitalism fails to produce goods in accordance with the society's requirement; thus, there is social wastage of economic resources.
4) Poor utilization of resources: The price mechanism under capitalism fails to employ resources of a country fully, hence unemployment and thus freedom of occupation becomes meaningless under capitalism.
5) Human welfare is neglected: This is done through entrepreneurial exploitation of workers and consumes, the system creates problems of employment and economic instability.
Socialism
This is an economic system where the state takes the major economic decisions through detailed planning. Countries that adopt this system do not believe in the efficacy of market forces. Production and distribution of goods and factors of production are done by state under the directives of planning authority. The decision as what to produce, how to produce and for whom to produce are taken by the planning authority that is why socialist economy is also called a plan economy.
Features of Socialism
1) Public ownership of means of production and distribution: This implies that all firms, financial institutions. Distributing agencies, means of transportation and communication etc. are not only owned but also controlled and regulated by the government department and State Corporation. The objective if socialist economy is societal welfare not profit as in case of capitalist arrangement.
2) Central planning: There exists a central planning authority, which formulates a comprehensive economic plan for the national economy. The intended objectives and targets are spelt out and major economic decisions regarding what, how, for whom to produce are made by planning authority.
3) Definite objective: Socialist economy operates within definite economic objectives and these may concern aggregate demand, full employment, and satisfaction of communal demand, distribution. Of national income, the amount of capital accumulation etc. in attempt to achieve these objectives necessitates formulation of plan that defines priorities and targets, which covers all aspects of the economy.
4) Freedom of consumption: Under socialism consumer's sovereignty implies that government in line with the preference of consumer generally owns production and the available commodities are distributed to the consumers at fixed price through the state.
5) Equality of income distribution: In socialist economy, there is great equality of income distribution because of absence of private ownership of means of production, private accumulation of capital and profit motive.
6) Planning and the pricing process: pricing process is under the watchful eye of the government who has power to control and regulate prices. Planning is the system of managing economic process involving production, investment and consumption. It is essence consists in determining economic targets and method for their implementation, planning and pricing complement one another in a socialist economy such that the two work towards the realization of known objectives.
Advantages of Socialism
1) Greater economic efficiency: central planning authority makes an extensive survey of resources and utilizes them in most efficient manner thereby avoiding wasteful competition. Societal welfare is maximized by producing socially useful goods and services which satisfy the basic wants of people such as food; shelter and clothing these enhance economic efficiency.
2) Greater welfare: There is less inequality of income because all citizens' work for welfare state (socialist economy) is paid their remuneration according to their ability, education and training. All rents, interest and profit received by state are expended for improving public welfare through provision of free education, housing, free public health services, social security to public etc.
3) Absence of monopolistic practice: There is state monopoly rather than private monopoly and as such undue and unnecessary exploitation of monopolistic private individual is avoided and thus improvement in standard of living of masses.
4) Absence of business fluctuation: Central planning authority controls and regulates production and consumption of goods and services in accordance with objectives and target of plan. This ensures economic stability and reduces the chances of overproduction and employment.
5) Prevention of certain forms of economic waste: Free enterprise capitalism is noted for its wasteful use of resources examples are, unnecessary product differentiation, unwarranted fragmentation and duplication of equipments and services, excess employment in sales promotion, misleading advertisement, conspicuous consumption etc. such forms of waste are virtually absent or can be easily prevented under socialism.
Disadvantage of Socialism
1) Loss of consumer's sovereignty: Consumers do not have freedom to buy commodities they want. They consume only commodities, which are provided by the central authority.
2) No freedom of occupation: Every individual is provided a job by the state but he cannot leave or change it.
3) Misallocation of resources: Central planning authority often commits mistake in allocation of resources because the entire work is carried out on trail and error basis.
4) Bureaucratic: A socialist economy is said to be a bureaucratic economy because it operates like a machine and hence does not provide the necessary initiative to the people to work hard. People work for fear of high authority not for any personal gain or self interest.
5) Emergence of state monopoly: Socialism leads to state monopoly of means of production which gives rise to ineffective and inefficient production and distribution of goods and services due to bureaucracy and misallocation of resources.
Mixed Economy
Mixed economy is combination between capitalist and socialist economy. It is an economy system where price mechanism and economic planning authority are used simultaneously. Hence there are both private and public ownership of means of production and distribution. Household and firms and some other take some decisions by planning authority.
Features of Mixed Economy
1) Public sector: all decision regarding what, how and for whom to produce is taken by the state. Public utilities such as road construction, power supply, water supply are in the side of public sector. These public utilities are operating for societal welfare maximization not for profit motives.
2) Private sector: There is private sector in which production and distribution of goods and services are carried out by private enterprise. Profit motive is the guiding principle in this sector.
3) Joint sector: there is joint sector where both state and private jointly run enterprise. It is organized on the basis of a joint stock company where majority of shares are held by the state.
4) Freedom and control: in mixed economy there is every freedom to own private property, earn profit, to consume, produce, distribute and to have any occupation of choice without limitations until and unless such possessions have an adverse effect on public welfare so that state intervenes in order to control and regulate the situation.
5) Economic planning: There is a central planning authority in a mixed economy. In this system, economy operates on basis of some economic plan. All sectors of economy function in accordance with the objectives, priority and targets laid down in the plan.
Advantages of Mixed Economy
1) Best allocation of resources: since mixed economy incorporate the goods features of both capitalism and socialism, the resources of the economy are utilized in best possible manner.
2) General balance: mixed economy maintains a general balance between the public and private sectors. There is competition as well as co-operation between the two sectors which is conducive atmosphere for achieving a high rate of capital accumulation and economic growth.
3) Welfare state: mixed economy contains all the features of the welfare state that provides social services such as health care, unemployment pay etc. to people who need them. Therefore, there is no exploitation either by the capitalist under free enterprise economy or by the state under centrally planned economy.
4) Stability: it ensures stability by reducing high unemployment and income inequality associated with capitalist economy.
Disadvantages of Mixed Economy
1) Non-cooperation between the two sectors: experience has shown that in mixed economy private and public sector do not see eye to eye with one another. They are at loggerhead because of their disparity in motives and as such they are not cooperative with one another.
2) Inefficient public sector: public sector of mixed economy is a bit burden on economy because it works inefficiently. The bottlenecks, which militate against efficiency of public sector, are bureaucratic control, over staffing of personnel, red-tepism, corruption, and nepotism among others. These bring about decline in production and huge loss.
3) Economic fluctuation: The experience of the working of mixed economic system in developed countries also reveals that they have not been able to remove economic fluctuation.
Distinctions between Micro & Macro Economics
The word micro has been derived from the Greek word micros, which means small. Microeconomics is the study of economic actions of individuals and small groups of individuals. It includes particular households, particular firms, particular industries, particular commodities, individual prices, wages and incomes. Thus microeconomics studies how resources are allocated to production of particular goods and services and how efficiently they are distributed. But microeconomics in itself, does not study the problem of allocation of resources to the economy as a whole.
The word macro is also derived from Greek word MAKROS which means large. Macroeconomics is the study of aggregates or averages covering the entire economy, such as total employment, national income, national output, total investment, total consumption, total saving, aggregate supply and demand, general price level, wage level and cost structure. In other words, it is aggregative economics, which examines the interrelations among the various aggregates, their determination and causes of fluctuations in them.
Microeconomics analysis deals with economic actions of single individuals as the name implies small. How a single firm maximizes profits, How a single producer minimizes cost etc. these are the main areas of studies in microeconomics. Thus, can be referred to as the study of an economy in small. Macroeconomics analysis on the other hand studies the economy as
the whole. It deals with economic affairs in the large. It concerns the overall dimensions of economic life the two can be linked to study of a forest (i.e. macro economic analysis) and a tree (micro economic analysis) within a forest. Thus, macro economic analysis studies the character of the forest independently of the trees, which composes it.
The objective of microeconomics is to suggest or identity the efficient means of resources allocation at micro level. It suggests most efficient ways of spending consumer's income. Most efficient combination of factor inputs to a producer and recommended most effective pricing policy to a firm or industry. In other word, objective of microeconomics on demand side is to maximize utility whereas on the supply side is maximizing profit at minimum cost.
The objectives of macroeconomics on the other hand are to achieve an efficient allocation
of resources at the level of economy as a hole. It concerns with how the broad aggregate can be manipulated to achieve optimum welfare in the economic. In other word, the main objectives of macroeconomics are full employment. Price stability, economic growth and favorable balance of payments,
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