I understand what capitalism and what socialism are, but I don't understand—why are the economic systems important?

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Lorraine Caplan | College Teacher | (Level 1) Educator Emeritus

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Believe it or not, whether you live in a capitalistic economy or a socialist economy, that economy will have a profound effect upon your life and the lives of everyone else living under that system.  But before we look at why, I would like to make a few general comments that might clear up some of your confusion and review both kinds of economies.  

First, we need to distinguish between a political system and an economic system. Students sometimes get confused about this difference.  A political system is a system that is used to govern people, while an economic system determines how goods and services are produced, bought, and sold.  For example, in the United States, we have a political system that is a constitutional democracy, meaning the people elect the leaders, and there is a document that limits what the leaders can do and that guarantees certain rights of the people. Our economic system is mostly capitalistic. On the other hand, socialism is often thought of as a political system and an economic system, and this is where confusion sometimes arises.  Because of this, the current trend is to refer to a socialist economy as a command economy. As you will see, this is a much better description, and it clears up that confusion.   

In a purely capitalist economy, all decisions on production and purchase are up to individuals and companies. A marketplace is created with the production of goods and services and buyers for these goods and services.  No one in the government controls prices, what will be produced, or how much will be produced.  No one in the government decides how much of a service or product a consumer will get. Price is determined by the market place. If there is too much of something and no one wants to buy, the price will go down. If there is too little of something and many people want to buy, the price will go up. So sellers and buyers are always adjusting the price in the market.  This is called the law of supply and demand.  Because the government does not control production, anyone can produce, and this creates competition.  Competition is also a factor in price. If there is no competition, a company can charge what it likes. If there is a great deal of competition, this keeps prices lower.  I doubt that any economy today is purely capitalistic, but these are the important attributes to bear in mind.

In a command economy, the government decides what will be produced, how much will be produced, who will get it, and at what price.  Individuals and companies have no choices at all.  The now disbanded Soviet Union was a command economy, and China is still largely a command economy, too.  The Chinese government decides, for example, how many houses are to be built, where they will be built, and what they will cost.  The Chinese government decides who will grow rice, how much rice will be grown, and to whom it will be distributed.  The Chinese government is experimenting a bit with some capitalistic ideas, but it remains largely a command economy right now. 

You can see that living in a capitalist economy and living in a command economy are going to be very different and have a powerful effect upon everyone.  If you live in a capitalist society and you want to buy a pair of shoes, you may save up your money and choose from thousands of different kinds of shoes.  If you live in a command economy, if you want a pair of shoes, you must wait until the government decides to produce them, and you are not only likely to have only one choice, but also, you might be lucky to find some shoes in the right size.  Command economies are like this because central planning for an entire nation never works out very well, and no one has any incentive to produce anything, just the government telling a person he or she has to do this. Some official sitting in an office is clueless about what kinds of shoes people want or need. These economies often result in shortages of some goods and surpluses of other goods that sit piled up in a warehouse.  On the other hand, if you live in a capitalist society, individuals and companies can choose to make all different sorts of shoes because they wish to make a profit, and so they will figure out what kinds of shoes people want. This results in a much more efficient kind of marketplace, really.  People have an incentive to produce more different kinds of goods because there is money to be made and because they are making their own choices. This makes people want to work harder and be more productive. When they do so, they have choices about what kinds of goods and services they will purchase, with no government telling them what they will get. 

Command economies sound fine in theory, but no country has ever managed to have one that worked out very well. Capitalistic economies, with some limitations upon them, for example, to protect workers and consumers, work out much better for everyone, with a more efficient and effective production and distribution of goods and services for all.  What kind of economy we live in matters a great deal, even when it comes to shoes! 

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