1.1.6 Free market economies, mixed economy and command economy Flashcards
The distinction between free market, mixed and command economies: reference to Adam Smith, Friedrich Hayek and Karl Marx
In a free market economy, individuals are free to make their own choices and own the factors of production without government interference
In a command 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
In a mixed economy, both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country
Knowledge on economists:
- Adam Smith (1723-1790) believed in the free market economy and the laissez-faire approach by governments. 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. 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. Smith concluded that each individual’s self-interest managed to produce and purchase the goods and services that society needed. 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.
- Friedrich Hayek (1899-1992) 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. Also, he said that central planning by governments led to what a small minority wanted being forced on the whole of society. 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.
- Karl Marx (1818-1883) 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.
The advantages and disadvantages of a free market economy and a command economy
FREE MARKET ECONOMY
Advantages:
- 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.
- Consumers have freedom of choice, called consumer sovereignty.
- 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.
- Because firms are in competition, they will produce goods at the lowest cost they
can, ensuring productive efficiency.
- In general, freer market economies tend to have higher growth.
Disadvantages:
- There tends to be high levels of inequality, since the rich own more factors of production and so can grow richer.
- There may be a lack of merit goods (goods considered as intrinsically good) and little control of demerit goods (intrinsically bad).
- Resources could be wasted on unproductive expenses such as advertising, switching the factors of production and providing competitive services.
- 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 ECONOMY
Advantages:
- The state provides a minimum standard of living, ensuring no one is extremely poor as there is less inequality.
- 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.
- 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:
- 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.
The role of the government in a mixed economy
- Creating a framework of rules:
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. - Supplements and modifies the price system:
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. - Redistributes income:
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. - Stabilises the economy:
The government will attempt to manage the level of demand in the economy to prevent extremes of too much or too little demand. They do this through fiscal and monetary policy.
