5 Major Functions of an Economic System (Explained)

The way of organizing the economic activities by a society for its smooth living is called an economic system. The economic system is a macro aspect of economics with comprise of the legal and institutional structure under which all economic activities of the people are directed and motivated.

major functions of an economic system
major functions of an economic system

Functions of an Economic System

Each and every economic system has to perform the following major functions:

1. What and How Much is to be Produced?

The most important function of an economy is to decide what goods and services are to be produced. As we know in a society wants are unlimited and resources are scarce and they have alternative uses.

Thus, all wants cannot be satisfied with the given resources and society is faced with the problem of choice.

The given resources are to be put to the production of different goods and services in such a way that the maximum wants of the consumer can be satisfied.

The society has to make a choice between consumer goods and capital goods.

Even in the case of consumer goods, the choice has to be made between goods of general consumption and goods of luxury.

In a capitalist system, these decisions are made through price mechanism while in the socialist system these decisions are taken by the public authorities.

Related: 5 Main Indicators of Economic Development (Explained).

2. How to Produce?

Another function of an economy is to decide how to produce which deals with the organization of production.

For this function, the following points are considered:

  1. The way of allocating resources to those industries whose products are most liked by the consumers.
  2. Which goods are to be produced in the public sector and which are in the private sector.
  3. Which firms will work in which industries and how the resources will be allocated to them.
  4. Which techniques of production will be used for optimum production?

The society should choose such type of organization of production which can satisfy the maximum wants of people effectively and efficiently.

3. How is Production Distributed?

Another important function of an economic system is the distribution of production in society.

The production is the result of the collective efforts of all the factors of production.

Equitable and efficient distribution of production is essential for which the following points are to be considered.

  1. How the distribution production is carried on among families, and government.
  2. The distribution of production should be based on the principles of equality and efficiency.

In a capitalist economy, this function of distribution operation is carried on through price mechanism and considerately is creates inequalities.

But in a socialist economy, it is done by the public authorities and consequently, equality is maintained.

Related: Logistics or Physical Distribution: Definitions, Characteristics, Objectives.

4. Rationing of Goods and Services

The function of an economy is to distribute the supply of goods and services so that it is adjusted to its demand.

The allocation should be done in such a way that all sections of society get the goods at a reasonable price and if these goods are in short supply during a very short period the rationing system should be introduced.

This function is performed in different ways in different economic systems.

In a capitalism system, it is done through price mechanism while in socialist economy statutory rationing, price and distribution controls are used for this purpose.

5. Economic Maintenance and Progress

In recent years it is expected from every economic system that the products and efficiency will not be adversely affected.

The efficiency will be maintained and efforts will be made to increase it.

Economic maintenance and progress can be attained only when the following points are taken into consideration:

  • The production capacity of the economy is maintained with an increasing population.
  • Depreciation of capital stock is done away with, and.
  • Production Technology and growth prospects are to be improved.

All these above factors are maintained in a capitalist economy through the price mechanism.

Depreciation of capital assets is compensated by charging the high price for the product.

The efficiency and productivity of labor are enhanced through financial and nonfinancial incentives and using the latest technology.

In a socialist economy, all these are based on social priorities and investments.

Thus, now you know the major functions of an economic system.

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