Posted by Anjali Kaur on May 31, 2020

What Do We Mean By An Economy?

Well, ‘Economy’ and ‘Economics’ are two different terms when we say ‘Economics’ we focus on the distribution of resources in such a way that human maximum wants can be satisfied because resources are limited. But, what about the meaning of an ‘Economy’? and, The components of an economy. That we will be learning today.

The economy is a system in which people get a living to satisfy their wants. In short, it means how people are earning their livelihood or meeting their regular spending needs.

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Components of The Economy

The economy has four components, that is four parts, which makes it easier to understand the concept of the economy better. Let’s discuss each component:

  1. Production: It is related to producing something of value. It is the process in which inputs are changed into final goods and services.
  2. Consumption: It is related to using or consuming something. It is the process in which goods and services are completely used up.
  3. Investment: It means saving for the future. It is the part of the production which is kept for future consumption.
  4. Distribution: It means buying and selling. The goods and services produced are sold by the seller to the buyer in exchange for money.

The components of an economy were not difficult to understand. When we say economy, we are talking about how people are driving their livelihood, which depends on production, consumption, investment, and distribution. If a commodity is produced, then we expect someone to consume it. We also tend to save for our future through different investment schemes (Like, investing in bonds, buying lands, or even as simple as creating a fixed deposit in the bank account). We save so that we can conduct our daily transactions that involve buying from a seller. To buy any commodity, we need money. So, that’s what the economy is.

Let’s look at the different types of economies. Most of you are already aware of them. Just to freshen up our memory, I will be discussing them in the easiest manner possible.

Types Of Economy

There are three main types of economy:

  1. Market Economy: Market economy is the one, where decisions regarding production, consumption, investment, and distribution of goods and services are done with the help of market forces. Now, what are market forces? Market forces are the demand and supply for goods and services in the economy. So, when the demand and supply curves intersect each other, we get the equilibrium price and equilibrium quantity. Note, there is no government intervention, it is a free economy, or you can say it is capitalistic; the private sector plays a vital role here.
  2. Socialist Economy: The opposite of the ‘market economy’ is a socialist economy. Here, decisions regarding production, consumption, investment, and distribution of goods and services are taken by the government only. No private sector or market forces are involved. Socialist economy is also known by other names like ‘Centrally Planned Economy’ or ‘Controlled Economy’ because it is under the control of the government.
  3. Mixed Economy: When you combine ‘market and socialist economy’ together, then we get a mixed economy. A mixed economy is the one, where some important decisions are taken by the government and the pricing decisions are taken with the help of the market forces of demand and supply.

Now, why there is a need to study different types of economy? Well, because every economy faces economic problems. Let’s have a look at the economic problems and their causes.

Economic Problems

Economic problems mean ‘problems of choice’ which occurs because resources are limited and these limited resources have different uses. For example, clean water is limited on earth, but the demand for such water is unlimited as water is used for so many different purposes ranging from bathing, drinking, cooking, washing, and so on. So, ultimately when we face the water shortage, we choose to use it wisely.

What causes economic problems?

The main reason behind economic problems are:

  1. Human wants are unlimited (It is true, look at your amazon shopping list, you will realize it).
  2. Resources are limited (Especially now in Covid-19 pandemic, when people are losing jobs, our resources to satisfy our need, that is, money is limited)
  3. Resources have alternative uses (Yes, ultimately we have to pay our bills, then we can think about buying something for our leisure)

To summarize, we learned that economy means; how people are earning their livelihood. We also read that production, consumption, investment and distribution are the parts of the economy. Then, we came to know about different types of the economy like market economy; where private sectors play a major role. then the socialist economy; where the government sector plays a major role and finally mixed economy; which includes both private and government sectors. We also saw that economic problems arise because of the scarcity of resources and unlimited wants for such resources for different purposes that further worsen the economic problems. That’s why we make choices to satisfy our maximum wants.

You can read more related posts:

  1. Introduction to Economics
  2. What do you mean by an economy?
  3. What are the Central problems of the economy?
  4. Production Possibility Curve
  5. What causes PPC to shift?
  6. What does the opportunity cost mean?
  7. The point on and off the Production Possibility Curve

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Disclosure: Some of the links on the website are ads, meaning at no additional cost to you, I will earn a commission if you click through or make a purchase. Please support me so that I can continue writing great content for you.

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