1.1.6 Free market economies, mixed economy and command economy Flashcards
Different market types
Different types of markets answer the ‘what to produce’, ‘how to produce it’ and ‘for whom to produce it’ questions in different ways.
1) Free market economy
2) Command economy
3) Mixed economy
Free market economy
In a free market economy, individuals are free to make their own choices and own the factors of production without government interference. Resources are allocated through the price mechanism. The consumer determines what is produced by their willingness to spend their money on a good.
- Consumers make decisions based on satisfaction and producers based on profit.
- There are no completely free markets in the world today, because the government has to intervene at least to an extent, for example by issuing money, protecting property rights and breaking up monopolies. Without this, the market mechanism could not work.
Adam Smith: Free market economy
- For free market economy: Smith believed in the free market economy and the laissez-faire (non-interventionist) approach by governments.
- Invisible hand: He explained how there was an ‘invisible hand’ in the market which allocated resources to everyone’s advantage, allowing the greatest good for the greatest number of people.
- Competition: He believed competition in the market caused lower prices as firms wanted to be competitive and so this benefits the consumer as they can get goods cheaply.
- Consumer satisfaction: Smith concluded that each individual’s self-interest managed to produce and purchase the goods and services that society needed.
- EVAL: However, he did argue that the state needed to provide goods/services which free markets wouldn’t such as: the laws, property rights and goods such as bridges and roads (public goods).
Friedrich Hayek: Free market economy
- Freedom: Hayek argued that state control of the economy leads to the loss of freedom. He believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom.
- Prioritises minority: Also, he said that central planning by governments led to what a small minority wanted being forced on the whole of society.
- Individuals know best: Hayek believed that, although individuals don’t make supply and demand decisions based on perfect information, they best know what they need in their own situation i.e. a consumer knows how much bread they need and a manager knows how many raw materials they need.
Advantages of free market economy
● Innovation as they are profit driven
● Investment encouraging economies of scale and therefore lower prices for consumers (and more choice).
● Automatic (immediate): The system is automatic due to the invisible hand; resources are moved out of production of a good when people stop wanting it or costs are too high.
● Consumer sovereignty: Consumers have freedom of choice, called consumer sovereignty.
● High motivation: There is high motivation as people know working hard could lead to high potential rewards, creating conditions where initiative and enterprise flourish.
● There is political freedom.
● Productive efficiency: Because firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency.
● Higher growth: In general, freer market economies tend to have higher growth
Disadvantages of free market economy
● Inequality: There tends to be high levels of inequality, since the rich own more factors of production and so can grow richer.
● Lack of merit goods: There may be a lack of merit goods (goods considered as intrinsically/ naturally good) and little control of demerit goods (intrinsically/ naturally bad).
● Resources could be wasted on unproductive expenses such as advertising, switching the factors of production and providing competitive services.
● Monopoly power: If competition disappears then there may be monopolies, who charge high prices and offer low quality of service.
● There is the problem of externalities
Command (planned) economy
In a command (planned) economy, all factors of production, except labour, is owned by the state and labour is directed by the state. There is no private property and everyone is assumed to be selfless, working for a common good. Resource allocation is carried out by the government, rather than the price mechanism. The government’s allocation may represent the wishes of the consumer and often focuses on the need to expand certain areas of the economy, such as weapon building.
- However, planning is so complex that some decisions are left up to the consumer. Workers receive wages and can spend this on what they want, within limits. Some goods can be purchased whilst others, such as houses, are allocated. Income distribution is determined by the government and all workers, no matter their job, tend to receive the same wage, products are standardised and prices are limited causing excess demand and queueing.
Karl Marx: Command economy
Anti-capitalist:
- Marx believed in the command economy and criticised capitalism. Marx believed that capitalist’s profit came from exploiting labour as they underpaid workers for the value that they actually created.
- He wanted remove the difference between the incomes of owners and workers and believed that capitalism would collapse leading to communism. Marx saw businesses growing and workers getting poorer, creating a two class system with a few wealthy capitalists and many underpaid workers.
- He thought more firms would fail because of competition causing unemployment, lower wages and higher prices and this would lead to discontent amongst the working class. His theory stated that these workers would inevitably rise against property owners and seize control of the means of production. This would lead to a democratic society where everything would be owned by everyone i.e. the fall of capitalism to begin communism.
Advantages of command economy
● Min standard of living: The state provides a minimum standard of living, ensuring no one is extremely poor as there is less inequality.
● Less wastage: There is less wastage of resources as there is no need for competitive services nor advertising, which is very expensive.
● Long term planning means that the industry doesn’t have to keep changing and shifting resources. This is important as some industries may take a number of years to get established and would fail if planning was short term.
● Standardised products means that they are produced cost effectively.
● Well-being driven rather than profit: As the government, who are generally motivated by the wellbeing of the country, rather than the companies, who are motivated by profit, decide resource allocation, objectives other than profit can be followed: merit goods are encouraged and increased whilst demerit goods aren’t produced.
Disadvantages of command economy
● It is impossible for the state to make so many decisions correctly, which could lead to over or under supply and a waste of resources.
● Decision making will be slow as it has to go through various stages and there could be an increase in bribery and corruption (an increase in bureaucracy).
● 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.
● Consumers lose their freedom and it is often led by dictators.
Mixed economy
Both types of economies (free market and command) have benefits but also major problems so most economies have tried to move towards some form of compromise economy, called a mixed economy.
This is an economy where both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country. Each country will have a different amount of control by the government, but it is usually between 40-60%.
Governments (states) role in mixed economy
- Creating framework of rules
- Supplements and modifies the price system
- Redistributes income
- Stabilises the economy
Creating framework of rules: govts role in mixed economy
They prevent the abuse of monopolies: a company with more than 25% of market share can be considered as having monopoly power so can take advantage of their customers due to the lack of competition and charge higher prices/provide a poorer service. They can protect customers as they pass a large amount of consumer protection laws to protect the consumers from poor quality products or services. They protect property rights, ensuring whatever a person owns cannot be taken away by someone else. Also, they ensure safety standards, protecting employers and employees.
Supplementing and modifying the price system: govt role in mixed economy
They produce public and merit goods, such as emergency services and transport, and limit the production of demerit goods like child pornography. Government action ensures the consideration of externalities.
Redistributing income: govt role in mixed economy
They move income from one group of people to another, from the rich to the poor. They use tax, such as income tax, to take money away from one group then give the money to the poor. This is in the form of benefits for those who are out of work or on low incomes, and in the provision of services for all, such as education and the NHS, allowing the poor to access these services when they might not have been able to afford to.
