1.1.6 Free market economies, mixed economy and command economy Flashcards
What is an economic system?
An economic system is a network of organisations used to resolve what, how much, how and for whom to
produce i.e. a way of solving the basic economic problem (when there are infinite demands on finite
resources).
What are the 4 economic systems?
Explain what a free market economy is.
Markets allocate resources through the price mechanism. An increase in
demand raises price and encourages businesses to put more resources into the production. The
quantity of products consumed by people depends on their income and income itself depends on
the market value of an individual’s work. In a free market system, there is a limited role for the
government, indeed in a pure free market system, the government limits itself to protecting property
rights of people and businesses using the legal system and protecting the value of money or the
value of a currency.
Explain what a command economy is.
in a planned or command system associated with a socialist or communist system, the government owns scarce resources. The state allocates resources and sets
production targets and growth rates according to its own view of people’s wants. Market prices play
little or no part in informing resource allocation decisions and queuing rations scarce goods.
Explain what a mixed economy is.
In a mixed system, some resources are owned by the public sector (government) and some are owned by the private sector. The public (or state) sector typically supplies public, quasipublic
and merit goods and intervenes in markets to correct market failure. Nearly all economies in
the world are mixed although that mix changes over time for example as some industries are
privatised (sold to the private sector) or nationalised (taken back into state ownership).
Explain the benefits of a free market
- An efficient allocation of scarce resources – factor inputs tend to go where the expected profit is
highest, and in turn this represents the goods/services most desired by consumers (economists often
link this to idea of consumer sovereignty). - Competitive prices for consumers as suppliers look to increase and then protect their market share.
- Competition drives innovation & invention bringing higher profits for businesses and better products
for consumers – economists often call this dynamic efficiency - The profit motive stimulates investment which encourages economies of scale (i.e. lower unit costs in
production) and, in turn, lower prices for consumers. - Competition through trade helps to reduce domestic monopoly power and increases choice.
- Historically, economies with a large free-market aspect to resource allocation have grown more
quickly than those with a command economy.
What are the disadvantages of free market economies?
- Some members of society may be unable to work e.g. the elderly, those with disabilities or additional
needs, parents with young children etc. Without government intervention, these people will likely live
in poverty. This can create significant inequality in an economy. - Goods that are bad for us (often called demerit goods) may be over-produced; these could include
products such as cigarettes and alcohol. Similarly, products that are very good for us (often called
merit goods) may not be consumed in large enough quantities; these could include healthcare and
education (which will not be provided by the government in a completely free-market system). - Because of the profit motive, firms may be tempted to cut costs, and so exploit labour (e.g. paying
low wages or using child labour), use environmentally unsound production methods etc. - Some firms may grow so large that they gain significant monopoly power, which allows them to
charge very high prices to consumers, which could be unfair. Without government intervention, there
may be no easy way to prevent this from happening. -
Public goods will not be provided. Examples include streetlights,
free-to-use roads, lighthouses, flood defences etc.
What are the advantages of command economies?
- There is generally a low level of inequality and a low level of unemployment. Many command
economies have had strong gender equality. - Resources are allocated according to the ‘common good’ rather than according to the ‘profit motive’.
This is likely to result in universal provision of healthcare and education, amongst other things. - It may be more straightforward / fast to get large-scale infrastructure projects built.
What are the disadvantages of command economies?
- Bureaucratic costs of central planning of resources – petty officialdom can lead to wasteful
inefficiencies and therefore higher costs. - Problems in fixing prices of goods and services – planners are unlikely to be as accurate as the market
in determining suitable prices. - Absence of incentives for both workers (i.e. no wage ‘differentials’) and businesses (i.e. no ‘profit
motive’) can damage productivity and also lead to large levels of over-employment. - Low productivity and weak incentives lead to rising losses for many state-owned businesses. The
incentive to innovate is also limited. - Changing consumer needs and wants are not expressed as preferences in markets – the state is often
slow to react to these - The state can suffer from information failures and corruption
- State-run economies are at higher risk of mal-investment driven by political motivations rather than
market-assessed cost-benefit analysis
How does Adam Smith explain the 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.
What did Smith conclude from each individual’s self interest?
Smith concluded that each individual’s self-interest managed to produce and purchase the goods and services that society needed.
However, why did Adam Smith warn that we should be wary of monopolies?
Adam Smith warned that we should be wary of businesses that become too large (i.e. monopolies) because of their tendency to raise prices. He recognised that the government should keep an eye on their activities, but believed it was dangerous for large businesses to influence politics and
legislation.
What is the role of the rich in the free market?
Smith also recognised that in a free market economy, some people would be rich ‘property owners’ i.e.
owners of the factors of production, and there would be far fewer of these people than labourers. He said
that one important role of government in this type of economic system would be to maintain law and
order, because the many poor would want to take over the property of the rich.
What was Karl Marx’s view of free markets?
He agreed that free markets would lead to large increases in productivity and output, but also thought that the impact on labourers would be terrible. Marx believed that the drive for profit by business owners in the capitalist system would push worker wages to ‘subsistence’ levels and that they would be exploited. He said that, ultimately, exploited workers would work together and overthrow capitalism in a revolution.
What was Karl Marx’s view of command economies?
Capitalism would be replaced by socialism. In this system, production would be coordinated centrally, and distribution of the goods made would be “to each according to his contribution”. Beyond this, though, Marx gave very little indication of how he thought a centrally-planned command economy would operate in practice.
