18- Types of Economies

Question 1

What is a free market economy?

Answer 1

A free market economy is based on supply and demand where prices set freely between seller and consumer, without intervention from the government.

Question 2

What is a command economy?

Answer 2

A command economy is where all resources are owned by the government or central authority, who decides what to produce, how to produce it and who for. Example include the former USSR, Cuba, North Korea although market activity did and does exist in all of these countries.

Question 3

What is a mixed economy?

Answer 3

A mixed economic system is a system that combines aspects of both capitalism and socialism. A mixed economic system protects private property and allows a level of economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims.

Question 4

Advantages of a free market economy?

Answer 4

• An efficient allocation of scarce resources – factor resources tend to go where the expected profit is highest.
• Competitive prices for consumers as suppliers look to increase and then protect market share.
• Competition drives innovation & invention bringing higher profits for businesses and better products for consumers.
• The profit motive stimulates investment which encourages economies of scale and lower prices for consumers.
• Competition through trade in goods and services helps to reduce domestic monopoly power and increases choice.

Question 5

Disadvantages of a free market economy?

Answer 5

• Free market activity can lead to a rise in the scale of income and wealth inequality as shown by rise in the Gini coefficient
• Businesses can develop monopoly power which leads to higher prices and damage to consumer welfare
• Under or non-provision of pure public goods (e.g. defence – goods which are non-rival and non-excludable)
• Under-provision of merit goods such as health and education – which many cannot afford – leading to lower social welfare
• Free markets may fail to address negative externalities from production and consumption – unsustainable growth
• Deregulated financial markets often prone to bouts of instability – the fall out from which affects millions not directly involved

Question 6

Advantages of command economies?

Answer 6

• Supporters of command economies argue that it enables the government to overcome market failure, inequality and create a society that maximises social welfare rather than maximises profit.
• Command economies can prevent abuse of monopoly power.
• Command economies can prevent mass unemployment, often a feature of capitalist economies.
• Command economies could produce goods which benefit society and ensure everyone has access to basic necessities.
• Although Command economies are associated with failing inefficient economies of the late Soviet Union and Cuba, in the 1920s and 30s, the Soviet Union made periods of very rapid economic growth. Between 1928–40 – the first three Five-Year Plans, the Soviet Union made rapid economic growth changing from a largely agrarian society to a major industrial nation. (This also occurred during a period of depressed world demand during the Great Depression.)

Question 7

Disadvantages of Command economies?

Answer 7

-Government agencies usually have poor information about what to produce. Centralisation means that decisions are taken by people who may have no access to what is actually happening. Command economies, like the Soviet Union, often produced goods that weren’t used.
-Unable to respond to consumer preferences.
Inefficient firms are protected and kept going; making it hard for resources to move to dynamic and efficient firms.
-Threat to democracy and liberty. A command economy creates a very powerful government which limits individuals rights to pursue economic objectives. -This invariably creates a climate where governments can extend their control into other areas of people’s lives.
-Bureaucratic. Command economies tend to be very bureaucratic with decisions held up by planning and committees.
-Price controls invariably lead to shortages and surpluses.

Question 8

Advantages of mixed economies?

Answer 8

• Incentives to be efficient. Most business and industry can be managed by private firms. Private firms tend to be more efficient than government-controlled firms because they have a profit incentive to cut costs and be innovative.
• Limits government interference. Mixed economies can reduce the amount of government regulation and intervention prevalent in a command economy.
• Reduces market failure. Mixed economies can enable some government regulation in areas where there is market failure. This can include:
• Regulation on the abuse of monopoly power, e.g. prevent mergers, prevent excessively high prices.
• Taxation and regulation of goods with negative externalities, e.g. pollution,
• Subsidy or state support for goods and services which tend to be under-consumed in a free market. This can include public goods, like police and national defence, and merit goods like education and healthcare.
• A degree of equality. A mixed economy can create greater equality and provide a ‘safety net’ to prevent people from living in absolute poverty. At the same time, a mixed economy can enable people to enjoy the financial rewards of hard work and entrepreneurship.
• Macroeconomic stability. Governments can pursue policies to provide macroeconomic stability, e.g. expansionary fiscal policy in times of a recession.
• Even libertarians who dislike government intervention believe there needs to be legal support for private property and government provision of law and order.

Question 9

Disadvantages of mixed economy?

Answer 9

• How much should the government intervene? Can be difficult to know how much governments should intervene, e.g. discretionary fiscal policy may create alternative problems such as government borrowing.
• Too much inequality? Mixed economies are criticised by socialists for allowing too much market forces, leading to inequality and an inefficient allocation of resources.
• Government failure. Mixed economies are criticised by free-market economists for allowing too much government intervention. Libertarians argue that governments make very poor managers of the economy, invariably being influenced by political and short-term factors.