1.1.6 - Free market, economies, mixed economy and command economy

Question 1

Function of an economy

Answer 1

To solve the basic economic problem - resources are scarce but wants are infinite

Question 2

Define economic system

Answer 2

Complex network of individuals, organisations and institutions which allocate resources.

Question 3

Types of economies

Answer 3

Free market economies

Mixed economies

Command economies (also called planned economies)

Question 4

Explain free market economies

Adam Smith advocated

Answer 4

Lets the market, consumers and producers decide how resources should be used without intervention from the state.

Question 5

Explain command economies

Karl Max advocated

Answer 5

Completely run by the state which decides how resources are used

Question 6

Explain mixed economies

Friedrich Hayek advocated

Answer 6

Mixture of free market and command structures. Includes intervention where the market may fail.

Question 7

Advantages of command economy

Answer 7

. State can place restrictions to ensure the economy is operating at an optimal level that improves the welfare of all people and does not have negative effects (negative externalities) such as environmental damage

. The state can make sure goods are provided that would otherwise not supplied by the market

. There is less wastage of resources as there is no need for competitive services nor
advertising, which is very expensive

. The state provides a minimum standard of living, meaning inequality will be low.

. merit goods are encouraged and increased whilst demerit goods aren’t produced.

Question 8

Disadvantages of command economy

Answer 8

. State may not have correct information and therefore unable to make effective policies

. State may be corrupt and make policies that benefit large companies who do not work in the consumer interest

. As everyone receives the same wage, there is less motivation and efficiency
because people know that working harder will not increase their standard of living.

Question 9

Advantages of free market economy

Answer 9

. Greater consumer choice

. A free market is usually more efficient in determining what consumers want and how to provide it than a government

. There is greater competition in a free market. This means firms will produce goods at the lowest costs, ensuring productive efficiency

. There is high motivation as people know working hard could lead to high potential
rewards, creating conditions where initiative and enterprise flourish. This means labour productivity is higher in free markets

Question 10

Disadvantages of free market economy

Answer 10

. Market failures exist without correction

. Greater level of unemployment and inequality

. Under provision of public goods

. Negative Externalities

. There may be a lack of merit goods (goods considered as intrinsically good) and
little control of demerit goods (intrinsically bad).

. If competition disappears then there may be monopolies, who charge high prices and offer low quality of service.

Question 11

Are there any pure free market economies?

Answer 11

No, government always steps in for certain aspects

Hong Kong and the US are the two countries closest to

Question 12

Examples of command economies

Answer 12

North Korea
China
Cuba

Question 13

What can be used to evaluate different types of economies?

Answer 13

. Choice

. Quality and innovation

. Effieciency

. Economic growth

. Distrubtion of income and wealth

. Risk

. Political freedom

Question 14

Explain choice

Answer 14

.More consumer choice in the market economy compared to command economy

. In command economy income after tax would be lower

. More workers are allocated jobs in command economies

. In free market economy more inequality in terms of choice

Question 15

Explain quality and innovation

Answer 15

. Free market economies have a stronger incentive to produce high quality goods as companies that fail to do so will be driven out of business. There is more competition in a free market than a command economy

Question 16

Explain efficiency

Answer 16

. Workers in command economies have little incentive work efficiently as guaranteed jobs and similar pay meant that they only had to work the minimum to keep the job

. Markets and workers in free market economies are more efficient due to more competition. However competition is limited as a few large firms dominate in those markets.

Question 17

Explain economic growth

Answer 17

. Planned economies can fall behind in terms of growth as planning the whole economy produced large inefficiencies.

. However, both mixed and free market economies at the same level of development seem to grow at very similar rates over time

Question 18

Explain Distribution of income and wealth

Answer 18

Free market economies tend to have higher levels of inequality than mixed economies. In mixed economies the planning process is more distributed than in a free market. High income earners also pay a larger proportion of tax in mixed economies

Question 19

Two main ways resources have been allocated

Answer 19

. Market mechanism
. Planning

Question 20

Define Market Mechanism

Answer 20

. Market Mechanism allocates resources through bringing buyers and sellers who agree on a price for a product being sold

Question 21

Define Planning

Answer 21

. Planning allocates resources through administrative decisions

E.g. Occurs within families when individuals make decisions about who gets gets what

E.g. Firms are also planned economies where managers decide how to allocate resources

Question 22

Role of state in mixed economy

Answer 22

. Achieve macro and microeconomic objectives