Economic Systems and Their Foundations

Every economy must answer three questions: what goods and services to produce, how to produce them, and for whom. These decisions are made by the marketplace, the government, or both. In the United States, the government and the free-market system together guide the economy.

The world's major economic systems fall into two broad categories: free market, or capitalism; and planned economies, which include communism and socialism. In reality, many countries use a mixed market system that incorporates elements from more than one economic system. The major differentiator among economic systems is whether the government or individuals decide how to allocate limited resources, what goods and services to produce, how and by whom they are produced, and how to distribute them to consumers.

A capitalist system guarantees certain economic rights: the right to own property, the right to make a profit, the right to make free choices, and the right to compete. The main incentive is profit, which encourages entrepreneurship. Competition leads to better and more diverse products, keeps prices stable, and increases the efficiency of producers.

In a communist economic system, economic decision-making is centralized: the government decides what will be produced, where, how much, where supplies come from, who gets the output, and what prices will be. Workers have no rewards for excellence, so productivity suffers. North Korea and Cuba are the best remaining examples.

A socialist state controls critical, large-scale industries such as transportation, communications, and utilities. Smaller businesses and those considered less critical, such as retail, may be privately owned. Finland, India, and Israel are examples of socialist economies.

Use the table to compare worker incentives across systems.