1.1.6 Types of economy Flashcards
What is a command economy?
It is completely controlled by the government and resources are allocated by the state.
Characteristics:
● There is public (state) ownership of resources
● The state determines price
● Producers aim to meet production targets set by the state
● The state allocates resources
● There is a greater equality of income & wealth than in a free market economy
(Karl Marx)
What are the advantages of a command economy?
1) Greater equality: the state can ensure that everyone can enjoy a minimum standard of living and that no one’s is extremely rich.
2) Macroeconomic stability: the state can ensure that booms and slumps are smoothed out.
3) External benefits & costs: these may be taken into account when planning production.
4) No exploitation: privately owned monopolies are unable to exploit workers and consumers.
5) Full employment: the state can ensure that all workers are employed.
What are the disadvantages of a command economy?
1) Inefficiency: the absence of the profit motive and competition may result in an inefficient allocation of resources.
2) Lack of incentives to take risks: again the absence of the profit motive may reduce incentives for investment.
3) Restrictions of freedom of choice: people would be directed into the jobs the state deems necessary.
4) Shortages and surpluses: If the state miscalculates supply and demand then there may be excess demand and/or excess supply of goods & services.
5) Bureaucracy: A vast army of officials is needed to allocate resources.
6) Decisions by the state rather than consumers leading to excess production of an unwanted good.
What is a free market economy?
An economic system in which prices are determined by supply and demand with no government intervention, it is controlled by individuals.
Characteristics:
• There is private ownership of resources
• Market forces supply & demand determine prices
• Producers aim to maximise profits - consumers aim to maximise utility
• Resources are allocated by the price mechanism
(Adam Smith, Friedrich Hayek)
What are the advantages of a free market economy?
1) Automatic system (invisible hand) resources are moved out of production of a good when people stop wanting it or costs are too high.
2) Consumer sovereignty: consumer spending decisions determine what is produced.
3) High motivation a people know working hard could lead to high potential rewards.
4) Economic & political freedom: consumers & producers have the right to own resources.
5) Efficiency: Competition and the profit motive help to promote an efficient allocation of resources.
6) Increased choice: Consumers have a wide choice of goods & services with a command economy.
What are the disadvantages of a free market economy?
1) Inequality those who owns resources are likely to become richer than those who do not own resources.
2) Trade cycles: Free market economies may suffer from instability in the form of booms and slumps.
3) Imperfect information: Consumers may be unable to make rational choices.
4) Monopolies: there is a danger that a firm may become the sole supplier of a product and then exploit consumers by charging prices higher than the free market equilibrium.
5) Externalities: There are costs and benefits to third parties that are not taken into account when goods are produced and consumed.
What is a mixed economy?
A mixture of the free market economy and the command economy, it combines both elements of capitalism and socialism.
• In mixed economies, some resources are allocated by the price mechanism while others are allocated by the state, it accepts both private businesses and nationalised government services like public utilities, such as the military and education.
What is the role of the state in a mixed economy?
The state performs a variety of roles, many of which depend on the political priorities of the party.
However, in most economies the state has a number of key roles, which include the following to a greater or lesser degree:
• Defence and internal security
• Provision of public goods
• Provision of public services such as education and health
• Redistribution from the rich to the poor poor
