ECONOMIC

SYSTEMS
 ECONOMIC SYSTEMS
An economic system is the method society uses
to allocate its resources (land, labour, capital,
entrepreneurship) to satisfy its needs.

What distinguishes one economic system from

another is the control of the factors of
production and the interaction of business,
government and consumers.
 ECONOMIC SYSTEMS AT A GLANCE
1.Capitalism
2. Communism
3. Socialism
4. Mixed Economy
5. Modern Economic System
 ECONOMIC SYSTEMS
Capitalism
• Capitalism is derived from the word capital which
means money or resources which can be distinguished
in the form of land and labor. Capitalism was born
during the industrialization period where products were
mass produced for example in Great Britain. Mass
production required machinery or capital investment
and a massive labor force. The wealthy industrialists
competed among themselves to maximize profit and
minimize costs which they did by enslaving people.
Slaves meant no labor costs, and more profit. The rich
became super rich and the poor became very poor.
 Capitalism
▪ Capitalism : Is an economic system where the factors of
production are in private hands.

▪ The ideology of classical capitalism was expressed for

the first time by Adam Smith in 1776.

▪ “One in which economic decisions are made freely

according to the market forces of supply and demand’’—
Adam smith

▪ No Interference of Government.
 The Main Features of the Capitalism
System:
o 1) Private ownership or enterprise, in a free market thus able
to produce any products and distribute it at will. There is no
central economic plan.

o 2)Each individual pursues his self-interest without

government interference.

o 3)High competition between the market players based on

the concept of survival of the fittest.

o 4)Markets and price systems dependant on the demand and

supply.
 Communism
Communism:
❑In this economic system the government controls
the factors of production, land , labor and capital
are under the control of government and
entrepreneur is supplied by the government.

❑Supply And Demand, Competition Have No

Influence.
 Socialism
• Socialism: Economic system in which much
ownership is private, by the government controls
the operations and direction of basic industries.

• This control and direction are based on the belief

that there are contain products and services that
everyone should have.
 The Main Features of the Socialism
System:

1) The central planning system decides what and

how much to produce. The motive to produce is
not profit but usefulness to society.

2) Socialists establish equitable income

distribution through public ownership of the
material means of production.

3) Public enterprise where the industry and price

of products are controlled by the government.
 Mixed Economic System
▪ An economic system that features characteristics
of both capitalism and socialism. A mixed
economic system allows a level of private
economic freedom in the use of capital, but also
allows for governments to interfere in economic
activities in order to achieve social aims. This
type of economic system is less efficient than
capitalism, but more efficient than socialism.
 Mixed Economy

o Mixed Economy: This is an Economic system

based on a market Economy with limited
government involvement.

o Here the government has two economic tools:

• The power of Tax.
• The power to spend.
 Modern Economic system
(Islamic Economic System)
Islamic Economic System: Islamic economics refers to the
economic system that conforms to Islamic scripture and
traditions.

‘A suitable combination of capitalism and socialism.’’

The central features of an Islamic economy are summarized as the

following:
1) "Behavioral norms and moral foundations" derived from
the Quran and Sunnah,
2) Zakat ,tax as the basis of Islamic fiscal policy, and
3) Prohibition of interest.
 The Main Features of the Islamic
Economic System:
1)Traders are allowed to trade in a free market
with no government interference. Hisbah was
established to monitor the market of wrongful acts.
Monopolies are not allowed.

2)Private ownership is a right of each Muslim.

The law of inheritance has been outlined in the
Quran, and if the person has no legal heir, the
property will belong to the public treasury.
3) Zakah is obligatory on all Muslims. The
non-muslims have to pay jizyah and kharaj
(land tax). Other forms of taxation are forbidden
in Islam for example toll and sales tax.

4) Riba or interest is forbidden in Islam. Allah

clearly says that whoever involves with riba is at
war with Him and His Rasul, Allah forbid!
 Budget Line
o A budget is defined as a financial plan. Its a good
idea to have a plan, a budget for your home and your
business.

o A budget is a financial plan , expressed numerically ,

prepared in a year prior to the execution year.

o A budget line is a line showing the alternative

combinations of any two goods that a consumer can
afford at given prices for the goods and a given level
of income.
 File:Budget constraint.svg

Budget constraint

Budget Line: A graphical depiction of the various

combinations of two selected products that a consumer can
afford at specified prices for the products given their particular
income level.
When a typical business is analyzing a two-product budget
line, the amounts of the first product are plotted on the
horizontal X axis and the amounts of the second product are
plotted on the vertical Y axis.
 File:Indifference curves showing budget line.svg

Indifference curve showing budget line

An individual should consume at (QX, QY).

The budget line is the total amount of money a consumer

has to spend on two goods. The price of the goods and the
income of the consumer are the constraints that limit the
consumer from buying how much he really wants. He has
to decide on the correct combination of the goods to buy and
this would happen where the budget line is tangent to the
indifference curve.
 Shift in Budget Line
• Budget line is drawn with the assumptions of
constant income of consumer and constant
prices of the commodities. A new budget line
would have to be drawn if either –

a) Income of the consumer changes, or

b) Price of the commodity changes.
 Consumer’s Equilibrium
The state of balance achieved by an end user
of products that refers to the amount of
goods and services they can purchase given
their present level of income and the current
level of prices. Consumer equilibrium
allows a consumer to obtain the most
satisfaction possible from their income. File:Indifference curves showing budget line.svg

For example, A consumer with limited

income may wish to purchase both fruit and
vegetables. However, the more fruit he buys,
the less vegetable he can purchase and vice
versa . The consumer equilibrium point will
be a point at which he can purchased enough
of each to gain the maximum satisfaction
with his purchase decision.
 Income Effect on Consumer's
Equilibrium

Income effect attributes how a change in the

consumer’s income influences his total satisfaction.
Assume that the prices of commodities that the
consumer purchases remain constant. Now, he is able
to experience more or less satisfaction depending upon
the change in his income.

Thus, we can define income effect as the effect caused

by changes in consumer’s income on his purchases
while prices of commodities remaining the same.
Figure 1 explains the effect of change in the consumer’s income on his
equilibrium level.

In figure 1, Point E is the initial

equilibrium position of the consumer. At
point E, the indifference curve IC1 is
tangent to the price line MN. Suppose
the consumer’s income increases. This
causes the budget line shifts from MN
to M1N1 and then to M2N2. Consequently,
the equilibrium point shifts from E to E1
and then to E2.

Income Consumption Curve

You can obtain income consumption curve (ICC) by joining all equilibrium points E,
E1 and E2 as shown in figure 1. Normal goods generally have positively sloped
income consumption curves, which implies that consumer’s purchases of the two
commodities increases as his income increases.
 Substitution Effect on Consumer's
Equilibrium
Suppose there are two commodities, namely apple and orange. Your
money income is TK. 100, which does not change. You need to
purchase apple and orange using the entire money income, i.e. TK.100.
Assume that the price of apple increases and the price of orange
decreases. What do you do in this case? You tend to buy more oranges
and less apples since oranges are cheaper than apples. What exactly
you are doing is that you are substituting oranges for apples. This is
known as substitution effect.

The substitution effect occurs because of the following two reasons:

(a) The relative prices of commodities change. This makes one
commodity cheaper and the other commodity costlier.
(b) Money income of the consumer does not change.
Figure 2 is helpful to understand the concept of substitution effect in a simple
manner.
In figure 2, AB represents the original budget
line. The point Q represents the original
equilibrium point, where the budget line is
tangent to the indifference curve. At point Q,
the consumer buys OM quantity of
commodity X and ON quantity of commodity
Y. Assume that the price of commodity Y
increases and the price of commodity X
decreases. As a result, the new budget line
would be B1A1. The new budget line is
tangent to the indifference curve at point Q1.
This is the new equilibrium position of the
consumer after the relative prices change.
At the new equilibrium point, the consumer has decreased the purchase of commodity
Y from ON to ON1 and increased the purchase of commodity X from OM to OM1.
However, the consumer stays on the same indifference curve. This movement along the
indifference curve from Q to Q1 is known as the substitution effect. In simple terms, the
consumer substitutes one commodity (its price is less) for the other (its price is more); it
is known as the ‘substitution effect.’
 Price Effect on Consumer's
Equilibrium
For simplicity, let us consider two-commodity model. In
substitution effect, prices of both the commodities change
(price of commodity Y increases and price of commodity X
decreases). However, in price effect, price of any one of the
commodities changes. Thus, price effect is the change in the
quantity of commodities or services purchased due to a
change in the price of any one of the commodities.
Suppose price of commodity X decreases.
In figure 3, the decline in the price of
commodity X is represented by the
corresponding shifts of budget line from
AB1 to AB2, AB2 to AB3 and AB3 to AB4.
The points C1, C2, C3 and C4 denote
respective equilibrium combinations.
According to figure 3, consumer’s real
income increases as the price of
commodity X reduces. Due to an increase
in the consumer’s real income, he is able
to purchase more of both commodities X
and Y.

Price Consumption Curve

You can derive the Price Consumption Curve (PCC) by joining all equilibrium
points (in the above example, C1, C2, C3 and C4). In the above figure, the PCC
has a positive slope. This means that as price of commodity X falls, the
consumer’s real income increases.