CHAPTER 1

An Introduction to Financial Institutions, Instruments, and Markets

The Role of an Economic System

Economic systems are designed to collect savings in an economy and allocate the available resources efficiently to those who either seek funds for current consumption in excess of what their resources would permit or to invest in productive assets.

The key role of an economic system is to ensure efficient allocation. The efficient and free flow of resources from one economic entity to another is a sine qua non for a modern economy. This is because the larger the flow of resources and the more efficient their allocation, the greater the chance that the requirements of all economic agents can be satisfied, and consequently the greater the odds that the output of the economy as a whole will be maximized.

The functioning of an economic system entails the making of decisions about both the production of goods and services and their subsequent distribution. The success of an economy is gauged by the extent of wealth creation. A successful economy is one that makes and implements judicious economic decisions from the standpoints of both production and distribution. In an efficient economy, resources will be allocated to those economic agents who are in a position to derive the optimal value of output by employing the resources allocated to them.

Why are we giving the efficiency of an economic system so much importance? Because every economy is characterized by a relative scarcity ...

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