There exists 3 types of Economic systems.

1. Free market enterprise,
2. Centrally planned, and
3. Mixed economies. 

1. The Free Market Economy/Enterprise (The Price System)

• The free market system is where the free market forces determine what is produced.
• The decisions reflect private preferences and interests.
• For the free enterprise to operate there must be a price system/mechanism.
• The price system is the situation where the vital economic decisions in the economy are reached through the workings of the market forces.
• The questions “What?”, “How?”, and “For whom?” are answered here and help greatly in decision making.
• The free market gives rise to the concept of Consumer Sovereignty – a situation in which consumers are the ultimate determinants, subject to the level of technology, of the type and quantity of commodities to be produced.
• Consumers are said to exercise this power by bidding up the prices of the goods they want most; and suppliers, following the lure of higher prices and profits, produce more of the goods.

Features of a free market system

1. Private ownership of resources: In the private sector a significant portion of resources are owned by individuals or companies, therefore the owners practice full control over the means of production, allocation, and exchange of products and also labor supply 
2. Freedom to participate: Any person is at liberty to take part in the market since the decision to produce or consume certain products is voluntary.
3. Self Interest as the Dominating Motive: Firms aim at maximizing their profits, workers aim at maximizing their wages, landowners aim at maximizing their return from their land, and consumers at maximizing their satisfaction
4. Competition: Economic rivalry or competition envisages a situation where, in the market for each commodity, there are a large number of buyers and sellers. It is the forces of total demand and total supply which determine the market price, and each participant, whether buyer or seller, must take this price as given since it’s beyond his or her influence or control.
5. Reliance on the Price Mechanism: Price mechanism is where the prices are determined on the market by supply and demand, and consumers base their expenditure plans and producers their production plans on market prices. Price mechanism rations the scarce goods and services in that, those who can afford the price will buy and those who cannot afford the price will not pay.
6. Limited Role of Government: In these systems, apart from playing its traditional role of providing defence, police service and such infrastructural facilities as roads for public transport, the Government plays a very limited role in directly economic profit making activities.

Resource allocation in a free enterprise

• Although there are no central committees organizing the allocation of resources, there is supposed to be no chaos but order. The major price and allocation decisions are made in the markets. The market being the process by which the buyers and sellers of a good interact to determine its price and quantity.
• If more is wanted of any commodity say wheat – a flood of new orders will be placed for it. As the buyers scramble around to buy more wheat, the sellers will raise the price of wheat to ration out a limited supply. And the higher price will cause more wheat to be produced. The reverse will also be true.
• What is true of the market for commodities is also true for the markets for factors of production such as labour, land and capital inputs.
• People, by being willing to spend money, signal to producers what it is they wish to be produced.
• Prices are the signals for the appropriate technology.
• The “for whom?” question is answered by the fact that anyone who has the money and is willing to spend it can receive the goods produced. Who has the money is determined by supply and demand in the markets for factors of production (i.e. land, labour, and capital). These markets determine the wage rates, land rents, interests rates and profits that go to make up people’s incomes.
• The distribution of income among the population is thus determined by amounts of factors (person- hours, Acres etc.) owned and the prices of the factors (wages-rates, land-rents etc.).

Advantages of a Free Market System

1. Incentive: People are encouraged to work hard because opportunities exist for individuals to accumulate high levels of wealth.
2. Choice: People can spend their money how they want; they can choose to set up their own firm or they can choose for whom they want to work.
3. Competition: Through competition, less efficient producers are priced out of the market; more efficient producers supply their own products at lower prices for the consumers and use factors of production more efficiently. The factors of production which are no longer needed can be used in production elsewhere. Competition also stimulates new ideas and processes, which again leads to efficient use of resources.
4. A free market also responds well to changes in consumer wishes, that is, it is flexible. Because the decision happen in response to change in the market there is no need to use additional resources to make decisions, record them and check on whether or not they are being carried out. The size of the civil service is reduced.

Disadvantages of a Free Economy

The free market gives rise to certain inefficiencies called market failures i.e. where the market system fails to provide an optimal allocation of resources. These include:

1. Unequal distribution of wealth: The wealthier members of the society tend to hold most of the economic and political power, while the poorer members have much less influence. There is an unequal distribution of resources and sometimes production concentrates on luxuries i.e. the wants of the rich. This can lead to excessive numbers of luxury goods being produced in the economy. It may also result to social problems like crimes, corruption, etc.
2. Public goods: These are goods which provide benefits which are not confined to one individual household i.e. possess the characteristic of non-rival consumption and non-exclusion. The price mechanism may therefore not work efficiently to provide these services e.g. defence, education and health services.
3. Externalities: Since the profit motive is all important to producers, they may ignore social costs production, such as pollution. Alternatively, the market system may not reward producers whose activities have positive or beneficial effects on society.
4. Hardship: Although in theory factors of production such as labour are “mobile” and can be switched from one market to another, in practice this is a major problem and can lead to hardship through unemployment. It also leads to these scarce factors of production being wasted by not using them to fullest advantage.
5. Wasted or reduced competition: some firms may use expensive advertising campaigns to sell “new” products which are basically the same as may other products currently on sale. Other firms, who control most of the supply of some goods may choose to restrict supply and therefore keep prices artificially high; or, with other suppliers, they may agree on the prices to charge and so price will not be determined by the interaction of supply and demand.
6. The operation of a free market depends upon producers having the confidence that they will be able to sell what they produce. If they see the risk as being unacceptable, they will not employ resources, including labour and the general standard of living of the country may fall.

2. Planned Economy

• Also referred to as command economy or government controlled economy, socialism or communism
• Is a system where all major economic decisions are made by a government ministry or planning organization. Here all questions about the allocation of resources are determined by the government.

Features of this system

1. The command economies relies exclusively on the state.
2. Although division of labor and specialization are found, the planned economies tend to be more self-sufficient and tend to take part in less international trade than market economies.
3. There is no consumer or producer sovereignty
4. Market forces do not determine the price of goods and services, they are set by the government
5. The government decides what to produce, how to produce and the person to produce
6. The government aims at providing goods and services to everyone but not profit maximization

Advantages of Planned System

1. Full use of resources: Central planning can lead to the full use of all the factors of production, so reducing or ending unemployment.
2. Large scale production: Economies of scale become possible due to mass production taking place.
3. Public services: “Natural monopolies” such as the supply of domestic power or defence can be provided efficiently through central planning.
4. Basic services: There is less concentration on making luxuries for those who can afford them and greater emphasis on providing a range of goods and services for all the population.
5. There are less dramatic differences in wealth and income distribution than in market economy

Disadvantages of the Planned System

• The centrally planned economies suffer from the following limitations:-

1. Lack of choice: Consumers have little influence over what is produced and people may have little to say in what they do as a career.
2. Little incentive: Since competition between different producers is not as important as in the market economy, there is no great incentive to improve existing systems of production or work. Workers are given no real incentives to work harder and so production levels are not as high as they could be.
3. Centralized control: Because the state makes all the decisions, there must be large influential government departments. The existence of such a powerful and large bureaucracy can lead to inefficient planning and to problems of communication. Furthermore, government officials can become over privileged and use their position for personal gain, rather than for the good of the rest of the society.
4. The task of assessing the available resources and deciding on what to produce, how much to produce and how to produce and distribute can be too much for the central planning committee.
5. Also the maintenance of such a committee can be quite costly.

3. The Mixed Economy

• There are no economies in the world which are entirely ‘Free’ or planned, all will contain elements of both systems.
• The degree of mix in any one economy is the result of a complex interaction of cultural, historic and political factors. For example the USA which is a typical example of a largely work-based society, but the government still plans certain areas of the economy such as defence and provides very basic  care for those who cannot afford medical insurance.

Features

1. The mixed economy includes elements of both market and planned economies.
2. The government operates and controls the public sector, which typically consists of a range of public services such as health and education, as well as some local government services.
3. The private sector is largely governed by the force of mechanism and “market forces”, although in practice it is also controlled by various regulations and laws.
4. Some services may be subsidized, provided at a loss but kept for the benefit of society in general (many national railways, for example, are loss making), other services such as education or the police may be provided free of charge (though they are paid for through the taxation system).
5. The private sector is regulated, i.e. influenced by the price mechanism but also subject to some further government control, such as through pollution, safety and employment regulation.

Advantages of the Mixed Economy

1. Necessary services are provided in a true market economy, services which were not able to make profit would not be provided.
2. Incentive: Since there is a private sector where individuals can make a lot of money, incentives still exist in the mixed economy.
3. Competition: Prices of goods and services in the private sector are kept down through competition taking place.

Disadvantages of Mixed Economy

1. Large monopolies can still exist in the private sector, and so competition does not really take place.
2. There is likely to be a lot of bureaucracy and “red tape” due to existence of a public sector.