Fundamentals of Financial Instruments, 2nd Edition

CHAPTER 1An 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 else for investments in productive assets.

The key role of an economic system is to ensure efficient allocation. 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 is the chance that the requirements of all economic agents can be satisfied, and consequently the greater are the odds that the economy's output will be maximized.

The functioning of an economic system entails making 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 consequently is one that makes and implements judicious economic decisions from the standpoints of production and distribution. In an efficient economy, resources will be allocated to those economic agents who are able to derive the optimum value of output by employing the resources allocated to them.

Why are we giving so much importance to the efficiency of an economic system? The emphasis on efficiency is because every economy is characterized ...