1.1.6 Free Market Economies, Mixed Economy And Command Economy Flashcards
What is a free market economy?
- In a free market economy, individuals are free to make their own choices and own the factors of production without government intervention
- resources are allocated through the price mechanism
- the consumer determines what is produced by their willingness to spend their money on a good
What is the difference between how consumers and producers make decisions?
Consumers make decisions based in satisfaction and producer make them based on profit
Are there free markets in the world today?
No, 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
What was Adam Smith’s input about free markets economies?
- he believed in the free market economy and the laissez-faire approach by governments
- 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 (laws, property rights and goods such as roads and bridges)
What was Friedrich Hayek’s input about free market economies?
- state control of economy leads to the loss of freedom
- the poor in free market countries were better off than those in command economies because at least they had personal freedom
- central planning of governments led to what a small minority wanted being forced on the whole of society
- he 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
What are advantages of free market economies?
- the system is automatic (resources are moved out of production of a good when people stop wanting it or costs are too high)
- consumers have freedom if choice (consumer sovereignty)
- high motivation as people know that working hard can lead to high potential rewards (creating conditions where initiative and enterprise flourish)
- political freedom
- as firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency
- freer market economies tend to have higher growth
What are disadvantages of free market economies?
- high levels of inequality (the rich own more factors of production and so can grow richer)
- lack if merit goods and little control of demerit goods
- resources could be wasted on u productive 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
- problem of externalities
What is a command 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
How is income distribution determined in a command economy?
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
What is Karl Marx’s input about command economies?
- believed in command economy and criticised capitalism
- believed that capitalist’s profit cane from exploiting labour as they underpaid workers for the value that they actually created
- he wanted to 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 (fall of capitalism to beginning of communism)
What are advantages of command economies?
- state provides a minimum standard of living, ensuing no one is extremely poor and there is less inequality
- less wastage of resources as there id 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
- standardised products means that they are produced cost effectively
- as the government decide resource allocation, other objectives (than profit) can be followed (merit goods are encouraged and increased whilst demerit goods aren’t produced
What are disadvantages of command economies?
- impossible for state to make so many decisions correctly (could lead to over or under supply and a waste of resources)
- slow decision making (has to go through various stages and there could be an increase in bribery and corruption)
- less motivation and efficiency as everyone receives the same wage (working harder will not increase their living standard)
- consumers lose freedom and its often led by dictators
What is 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 has a different amount of control by the government, but it is usually between 40-60%
What is the government’s role in a mixed economy?
- creating a framework of rules: prevent abuse of monopolies, protect customers, protect property rights, ensure safety standards
- supplements and modifies the price system: produce public and merit goods and limit production if demerit goods
- redistributes income: move income from rich to the poor, use tax (income tax) to take money from one group and then give it to the poor i. Form of benefits
- stabilises the economy: attempts to manage the level of demand in the economy to prevent extremes of too much or too little demand (through fiscal and monetary policy)
