The term economic system has been defined by J. R. Hicks as ‘an organisation of producers to satisfy the needs of consumers’.

It is a mecha­nism for tackling the two problems of scarcity and choice. Due to scarcity of economic resources, every society has to find some means of allocating resources among alternative ends or uses.

In the present-day world three basic allocative mechanisms perform this function:

The private enterprise economy (or capitalism), in which resources are allocated through markets;


The controlled planned economy (or socialism), in which resources are allocated by the State; and

The mixed economy, in which resources are allocated both by the market and by the State. Nowadays we see another mixed economic system, viz., market socialism.

The institutions and organisations in an economy influence economic decisions and economic outcomes. Market forces play an important role in the allocation of resources in mixed capitalist countries such as the USA Canada, Australia, Japan and Germany. Government action is also impor­tant. Private industries are often regulated by the government.

Up to 1991 one-third of the world’s population lived in the Soviet Union (now known as the Commonwealth of Independent States), Eastern Europe and China. These societies were organised along socialist lines. They were characterised by central planning and government ownership.


Market-directed capitalism and centrally planned socialism are two alternative eco­nomic systems (or systems of economic organisation). There are, however, many variations of each.

All economic systems, despite their differences, face similar constraints. Scarcity of economic goods confronts individuals and nations alike. No nation is ever able to produce as much as its citizens would like to consume.

Therefore, regardless of economic organisation, choices must be made. The decision to satisfy a particular need or desire leaves many other desires unsatisfied. All economic systems are constrained by the law of scarcity.

Contrasting Capitalism with Socialism:


J. Schumpeter defined socialism as “an institutional pattern in which the control over means of production and over production itself is vested with a central authority or, in which, as a matter of principle, the economic affairs of society belong to the public and not to the private sphere.”

As Schumpeter’s definition implies, capitalist and socialist economic organisations differ in two important respects — ownership of physical capital and resource allocation.

Socialism refers to a system of economic organisation in which (a) the ownership and control of basic productive resources rest with the State and (b) resource allocation is determined by central planning rather than by market forces. By contrast, capitalism refers to an economic system based on private ownership of productive resource and allocation of goods ac­cording to the signals provided by free markets.

Table 1 summarises the distinctive characteristics of capitalist and social­ist economic organisations. Capitalist countries are characterised by private ownership of assets and the use of market forces to coordinate the actions of buyers and sellers and determine the allocation of commodities and factors of production.

Markets also coordinate employment and investment decisions and determine the distribution of income under capitalism. By contrast, government or state ownership (or control) of physical assets (such as capital and land) and the allocation of resources by central planning are the distinctive features of socialist economic organisation.

Under socialism the central planners also determine the pattern of employment and invest­ment as well as the distribution of income.

Contrasting Capitalism with Socialism

Every economic system — be it capitalist or socialist — must have a mechanism that coordinates the economic activity of micro-units—consum­ers, factor owners, and business firms. The mechanism has to solve such problems as the use of resources, the optimum production of desirable goods and services, and the distribution of income.

Under market-directed capitalism economic activity is coordinated by contractual agreements between private parties, who possess property rights to products and resources. There is no central planning mechanism.


Market prices direct the actions of decision makers (i.e., millions and mil­lions of diverse individuals and business firms). The forces of demand and supply push prices up or down in response to the decisions of individual buyers and sellers.

In a socialist economy resources are used and allocated in accordance with centrally determined and administered schemes. The central planning authority takes important economic decisions, such as what and how much will be produced, what the relative proportions of investment and con­sumption of various commodities will be, how resources will be used in production, and to whom will the product be distributed.

The central plan also includes decisions on various other aspects such as quantities of raw materials and inputs to be used, techniques of production to be adopted prices, wages, locations of firms and industries and the employment of labour. As a general rule socialist economic objectives reflect the preferences and value judgments of central planners. These objectives may or may not reflect the views of consumers.