1.1.6 Free market economies, mixed economy and command economy

Question 1

Capitalist economy

Answer 1

An economic system organised along capitalist lines uses market-determined prices to guide our choices about the production and distribution of goods. One key role for the state is to maintain the rule of law and protect private property.

Question 2

Command economy

Answer 2

An economic system where most factor resources are allocated by the government, with few officially sanctioned private markets (e.g. ex-Soviet bloc countries prior to their transition into market economies, modern-day North Korea and Venezuela).

Question 3

Consumer sovereignty

Answer 3

The desires and needs of consumers control the output of producers. Consumer sovereignty exists when an economic system allows scarce resources to be allocated to producing goods and services that reflect the wishes of consumers. Sovereignty can be distorted by the effects of persuasive or misleading advertising.

Question 4

Economic planning

Answer 4

Government policies aimed at influencing trends in the economy.

Question 5

Economic system

Answer 5

An economic system is a network of organisations used to resolve the problem of what, how much, how and for whom to produce.

Question 6

Free market

Answer 6

System of buying and selling that is not under the control of the government, and where people can buy and sell freely, or an economy where free markets exist, and most companies and property are not owned by the state. Market forces of supply and demand set prices.

Question 7

Friedrich Hayek

Answer 7

An Anglo-Austrian economist and philosopher best known for his criticisms of the Keynesian welfare state. His approach stems from the Austrian school of economics and emphasises the limited nature of knowledge. 1899 - 1992.

Question 8

Karl Marx

Answer 8

A German philosopher, economist and political theorist. He was a hugely influential thinker and co-authored the pamphlet ‘The Communist Manifesto’ which was published in 1948 and asserted that all human history has been based on class struggles, but that these would ultimately disappear with the victory of the proletariat. 1818 - 1883.

Question 9

Mixed economy

Answer 9

Where resources are partly allocated by the market and partly by the government.

Question 10

Planned economy

Answer 10

In a planned economy, decisions about what to produce, how much to produce and for whom are decided by central planners working for the government rather than allocated using the price mechanism.

Question 11

Transition economies

Answer 11

Transition economies are involved in a process of moving from a centrally planned economy to a mixed or free market economy.

Question 12

What did Adam Smith believe in relation to free market economies?

Answer 12

Adam Smith (1723-1790) advocated for a free market and the laissez-faire approach, meaning minimal government intervention. He described the “invisible hand,” where self-interest drives economic benefits for all. Smith believed competition in the market led to lower prices, benefiting consumers. However, he also argued that the government should provide essential services like laws, property rights, bridges, and roads that the market can’t efficiently supply.

Question 13

What did Friedrich Hayek believe in relation to free market economies?

Answer 13

Friedrich Hayek (1899-1992) argued that state control of the economy leads to a loss of freedom. He believed that the poor in freer market countries were better off than those in command economies because they had personal freedom. He argued that central planning by governments imposed the desires of a small minority on the entire society. Hayek believed that, even though individuals don’t have perfect information, they best know their own needs—like a consumer knowing how much bread they need or a manager knowing how many raw materials they require.

Question 14

What did Karl Marx believe in relation to free market economies?

Answer 14

Karl Marx (1818-1883) believed in a command economy and criticised capitalism. He argued that capitalists profited by underpaying workers and exploiting their labour. Marx aimed to eliminate the income gap between owners and workers, predicting that capitalism would collapse and lead to communism. Marx believed competition would cause firms to fail, leading to unemployment, lower wages, and higher prices, resulting in working-class discontent. His theory posited that workers would eventually rise against property owners, seize the means of production, and create a democratic society where everything was commonly owned, marking the fall of capitalism and the start of communism.

Question 15

Merit goods

Answer 15

goods or services considered to be beneficial for people that would be under-provided by the market and so under-consumed

Question 16

Demerit goods

Answer 16

Goods that are considered to be undesirable for consumers and are over-provided by the market (intrinsically bad)

Question 17

Externalities

Answer 17

a consequence of an industrial or commercial activity which affects other parties without this being reflected in market prices

Question 18

Monopoly

Answer 18

a company with more than 25% market share that can take advantage of their customers due to the lack of competition and can charge higher prices/a poorer service

Question 19

What is the role of state in a mixed economy?

Answer 19

• Ensure safety standards
• Protect property rights
• Prevent the abuse of monopolies Limit the production of demerit goods
• Considers externalities
• Produce public and merit goods eg emergency services and transport
• Redistribute income via income tax
• Provision of services such as education and healthcare
• Stabilises the economy via fiscal and monetary policy
• Regulates the economy - consumer protection, environmental standards and financial, markets eg Environmental Protection Agency (EPA)

Question 20

Advantages of a command economy

Answer 20

• Minimum standard of living
• Less wastage of resources as there is no need for competitive services
• Long term planning means industries do not have to repeatedly change resources
• Standardised products means they are produced cost effectively
• The government is motivated by the wellbeing of the country so merit goods are encouraged

Question 21

Disadvantages of a command economy

Answer 21

• The state can’t make decisions correctly which could lead to a waste of resources
• Increased bureaucracy (bribery and corruption)
• Less motivation and efficiency as there is a set wage
• Consumers lose their freedom
• Dictatorship

Question 22

Advantages of a free market economy

Answer 22

• Automatic system due to the invisible hand; resources are moved out production if costs are too high or unwanted
• Consumer sovereignty
• High motivation due to high rewards
• Political freedom
• Competition leads to productive efficiency
• Higher growth

Question 23

Disadvantages of a free market economy

Answer 23

• Resources could be wasted on unproductive expenses like advertising or switching the factors of production Inequality
• Lack of competition may lead to monopolies who charge high prices and low quality
• Externalities
• Lack of merit goods and little control of demerit goods
• Market failure

Question 24

Market failure

Answer 24

market fails to allocate resources efficiently