Rationing Systems

Economics can be split into different sections in order to simplify things:

Microeconomics and macroeconomics

Microeconomics: This is the part of economics that deals with the economy of consumers or households or individual firms. For example is studies how individual consumers make their decisions about demand and expenditure.

Macroeconomics: This is the part of economics that looks at the economy as a whole (usually on a national scale). It includes all things in the economy, such as unemployment and inflation.

Positive and normative economics

Positive economics: This deals with the areas of economics that are able to be proven correct or false. For example, positive economics would involve statements such as “The inflation rate in Finland for 2008 was 3.8%”.

Normative economics: This deals with the areas of economics that are subjective to personal opinions and beliefs.

Economists and model building

Economists tends to build models in order to illustrate their theories and test the effects of changing variables. To determine the effect of changing a single variable, economists must assume that the other variables remain the same, this is called “ceteris paribus” (in Latin: all other things being equal). Such a model is figured below:

Circular flow of income model

Figure 1.1.2 - The circular flow of income

Figure 1.2 is a circular flow model, it is the simplest representation of an economy. The model shows households as the groups of individuals in the economy who perform two functions, they are the:

  • consumers of goods and services
  • owners of the factors of production


This part of the economy is know as the private sector, because it is the part of the production in the economy that is owned by private individuals. Note that this simplified model ignores two major parts of the economy, the government and international trade.

Durable vs. non-durable

Good as well as services can be split into two groups:

These are consumed over time, such as a car (goods) or insurance (services).

These are consumed in a short period of time, such as a slice of pizza (goods) or a haircut (services)

Panned economies vs free market economies

Because the resources available to us are finite, they must be rationed, and so must the goods and services produced using the resources.

Theoretically, there are two main rationing systems:

Planned economies
In a planned economy, all decisions concerning the basic economic problem are made by the government. All resources are collectively owned and the government rations resources, goods and services. It sets wages, production and the price of products. Decisions are made by the government on behalf of and (theoretically) in the best interest of the people.


  • Too complicated to plan efficiently 

The biggest downside of a planned economy is that the amount of planning needed is impossible to be done efficiently by one body, this results in the misallocation of resources causing shortages and surpluses in different sectors.


  • Inefficient use of resources

Because there is no pricing system, resources will not be used efficiently.
Distorted incentives Workers with guaranteed employment and managers who gain no share of profits are difficult to motivate, causing output and/or quality to suffer.


  • Government dominance

The dominance of the government may lead to loss of personal liberty and freedom of choice.


  • Government power

The government may not share the views of the people and enforce plans that are not popular and even corrupt.


Free market economies

In a free market economy, all production is in private hands, prices and wages are set by supply and demand. Prices are used to ration goods and services


  • Demerit goods

Demerit goods, such as drugs, will be over‐provided by a high profit incentive.


  • Under‐provision of merit goods

Merit goods, such as education will only be provided to those who can afford it.


  • Resources may be used up to quickly

Driven by high profits and cost minimization resources may be used up too quickly and the environment may be damaged.


  • Some members of society will fail

People such as handicapped people, orphans and the unemployed will not be able to look after themselves and will fail to survive.


  • Firm dominance

Firms may be able to grow huge and dominate the market causing high prices, loss of efficiency and excessive power.


In reality, all economies are a mix of both the free market system and the planned economy system, only tending towards one system more than the other.

Transition economies
Some economies which were in the past mainly based on the planned economy system are moving towards the free market system. These economies are known as transition economies.

Economic growth

National income
To see the level of growth in an economy, we look at the national income. National income is the value of all goods and services produced in the economy in a certain time period (usually one year). There are three different ways of measuring national income, this is demonstrated in figure 1.3:

Methods of measuring national income

Figure 1.1.3 - The different methods of measuring national income;

To measure national income we add up all the activity along routes (a), (b) or (c). We cannot measure the activity along the FOP route as it is too difficult to measure their value.

Real national income
Rising prices (inflation) will cause the national income value to be overstated. Therefore to get the “real” value we must ignore inflation. Once inflation has been taken into account we call it the real national income.

Real national income per capita
If the real national income increases from one year to another then growth has occurred. However if the population increases by the same percentage or more then an increase per head of population has not occurred. Thus we must look at the increase in national income per capita in order to show economic growth.

Economic growth means a movement of the point inside the PPC towards the curve as shown in figure 1.1, it is actual growth.

Economic development

Growth vs. development
Economic growth is a measure of the increase in real national income per capita. If growth occurs it does not mean that the average citizen will be better off, for example, if most of the increase in real national income is caused by something that does not directly affect most citizens (such as an increase in the military’s equipment) the average citizen will not have received additional income.

On the other hand, economic development is a measure of welfare, taking into account more than just monetary measurements. Things such as social, health and education indicators will also be taken into account.

Human development index
The human development index (HDI) is the most commonly used measure to rate countries in order of development. Each country is given an HDI value between 1 and 0 (1 being the most developed). The HDI rating system takes into account adult literacy rate, life expectancy, real national income per capita and more.

Rating values:

  • 1 ‐ 0.8 means high human development
  • 0.8 ‐ 0.5 means medium human development
  • 0.5 ‐ 0 means low human development


It should be noted that there will not be a noticeable difference between a country that is just above and one that is just below an indication of development. For example, there will be no noticeable difference between a country that has an index of 0.79 (medium) and one that has 0.8 (high).

Sustainable development
If an economy destroys it’s environment and uses up all of it’s available resources in order to grow, it will not be able to grow in the future. Thus economies must limit their growth in order not to use up resources too quickly. This is called sustainable development and is defined as: development that meets the needs of the present without compromising future generations of meeting their own needs.