CH6 Types of economy

Question 1

What is the function of an economy?

Answer 1

the function of an economy is to resolve the basic economic problem - resources are finite, but wants are infinite
-resources therefore need to be allocated.

Question 2

what are the 3 dimensions that the allocation of resources has?

Answer 2

1) what is to be produced?
-should it be pizzas, tanks, or holidays for example
2) How is it to be produces?
-for example, is it going to be produced in London or in Manchester? Is it going to be made using the latest tech or by hand?
3) For whom it is to be produced?
-should products be equally distributed amongst the population? Should a small number of people be able to secure 100 times the amount the majority gain?

Question 3

What is an economic system?

Answer 3

an economic system is a complex network of individuals, organisation and institutions which allocate resources. This is done within social systems, such as the family or the local neighbourhood, and legal systems such as the British or EU legal systems

Question 4

What are the three ‘actors’ within an economic system?

Answer 4

-individuals: customers and workers. They may own factors of production which they supply for the production process
-groups: firms, trade unions, political parties, families and charities are just some of the groups which might exist in an economic system
-government: gov might range from a local parish council, to a local police authority, to a national parliament or supranational body like the European Commission. One key role of government is to exercise power. It establishes or influences the relationship between individuals and groups, for instance through the passing of laws or the enforcement of laws

Question 5

what are the 2 main ways in which resources have been allocated?

Answer 5

1) The market mechanism
2) Planning

Question 6

explain one of the ways in which resources have been allocated: The market mechanism

Answer 6

-the market mechanism allocates resources through bringing together buyers and sellers who agree on a price for the product or resource being sold.
-in the market for crisps, for example, crisp manufacturers sell their product via shops and supermarkets to buyers like you. In the market for teachers, schools hire (i.e. buy the services of) teachers and teachers sell their labour.

Question 7

explain one of the ways in which resources have been allocated: planning

Answer 7

-planning allocates resources through administrative decisions.
-planning occurs within families when individuals make decisions about who in the family is to get what. E.g adults will make decisions about children’s Christmas presents or how much the household spends on heating.
-firms are also planned economies where managers decide how to allocate resources.
-at a national level, governments and government bodies such as the NHS, allocate resources through planning. E.g. in a budget, the Chancellor will announce plans for how the government will spend money.

Question 8

What are the 3 main types of economy?

Answer 8

-free market economies
-mixed economies
-command economies

Question 9

Explain free market economies?

Answer 9

in free market economies the majority of resources are allocated through markets rather than through government and planning.

Question 10

are there any examples of pure free market economies?

Answer 10

no, however, Hong Kong and the United States have a great proportion of their resources allocated by the market than economies such as Sweden or Germany.
-in the United States, public (i.e. government) spending accounts for around 37.5 percent of total output. The government, through the planning mechanism, allocates resources, for example for education, defence, roads, policing and the justice system.
-Hong Kong and the United States therefore tend to be called ‘free market economies’

Question 11

explain mixed economies

Answer 11

-in mixed economies, more resources are allocated through government planning than in free market economies.
-two key areas which distinguish free market and mixed economies are welfare benefits and healthcare. In mixed economies, there tends to be a greater redistribution of income through welfare benefits such as state pensions, unemployment and sickness benefits, and child benefits. Mixed economies also tend to be the ones where the healthcare system is administrated and financed by the state, as in the UK.
-in pure free market economies, healthcare would be entirely financed by the private sector and, in theory, there would be no welfare benefit system

Question 12

in mixed economies, what percentage of resources are typically allocated by the government and free market?

Answer 12

typically between 40 per cent and 60 per cent

Question 13

Explain command economies

Answer 13

-in command (or planned or centrally planned) economies, most resources are allocated by the state and the market mechanism only plays a small part.

Question 14

what is the largest planned economy today?

Answer 14

it is China, although it is moving towards a mixed economy
-Cuba and North Korea are two other examples.
-before 1990, the Soviet Union and Eastern European countries such as Poland and Romania were also planned economies

Question 15

on average, in which type of economy do individual citizens have more choice?

Answer 15

comparing the United States with the former Soviet Union in 1985, or North Korea or Cuba today, it is clear that individual citizens on average have more choice in free market economies.
-planning tends to produce uniform products. So in the Soviet Union, everything from cars to shoes to food was mass-produced in large quantities but with little variety. In a market economy, consumers can choose between thousands of different variants of hundreds of different cars.
-as workers, in a market economy, people have choices about which jobs to apply for. In planned economies, there tends to be much more direction with workers being allocated jobs.
-citizens also have far less income after tax in planned economies than in free market economies. The amount they are free to spend on products of their choice is therefore much smaller.
-However, choice has its limitations. In free market economies, those with high incomes or high levels of education have far more choice than those with low incomes or low levels of education. Choice for an unemployed worker in a high-unemployment area might be very limited.

Question 16

What is one advantage claimed of a free market (hint: quality and innovation)

Answer 16

-one advantage claimed of a free market economy is that there are strong incentives built into the system to innovate and produce high-quality goods.
-companies which fail to do both are likely to be driven out of business by more efficient firms. However, this assumes that consumers or buyers have the power to make free choices. In practice, many markets are dominated by a few large producers which manipulate the market through advertising and other forms of marketing in order to exploit the consumer.
-so whilst choice and innovation are greater than under planned systems, the advantages of free market economies may not be as great as it might at first seem

Question 17

the planned economies of the Soviet Union and Eastern Europe proved to be what?

Answer 17

-they proved to be inefficient.
-one major problem was that workers and managers had little incentive to work efficiently.
-Usually guaranteed their jobs, they only had to meet their minimum work targets to stay out of trouble.
-markets tend to lead to greater efficiency because of competition. Firms in a competitive market have to be efficient to survive and make a profit. However, competition in many markets in mixed and free market economies is limited because a few large firms dominate those markets. Also, large firms are mini-planned economies in themselves and often struggle to maintain efficient production through planning in exactly the same way that planned economies such as the Soviet Union struggled to be efficient.

Question 18

evaluate economic growth in terms of the different types of economies

Answer 18

-it is frequently claimed that the more market orientated an economy, the higher will be the rate of growth of its overall economy. Markets are assumed to be dynamic whilst government control is assumed to dampen innovation and best practice. The planned economies of the USSR and Eastern Europe certainly fell behind in terms of growth. Planning the whole economy produced large inefficiencies.
-however, both mixed and free market economies at the same level of development seem to grow at very similar rates over the long term. Free market economies do not seem to have higher rates of growth than mixed economies over time

Question 19

what do free market economies tend to have higher levels of?

Answer 19

-they tend to have higher levels of inequality than mixed or planned economies.
-this is because resources produced by government through the planning process tend to be distributed more equally than would be the case in a free market. Higher income earners and wealth owners also tend to pay a larger proportion of tax in mixed compared to free market economies

Question 20

what do free market economies tend to expose their citizens to more of?

Answer 20

-to far more risk than mixed or planned economies.
-for example, there tends to be far less provision for risks associated with ill health, unemployment and old age in free market economies.
-the well off can afford to spend their way out of problems. However, the poor can be left with no healthcare, no job, no house and no food.
-in mixed and planned economies, there tend to be a ‘cradle to the grave’ bundle of services and benefits provided by government for citizens.

Question 21

what have all planned economies in the 20th century and 21st century curbed to enforce control?

Answer 21

-all planned economies in the 20th and 21st century have curbed political freedoms to enforce control.
-almost all have been totalitarian police states.
-in contrast, both mixed and free market economies have been associated with political freedom

Question 22

in his book, what does Adam Smith explain? what did he argue? what did he attack

Answer 22

-in his book (An enquiry into the nature and causes of the wealth of nations) he explained how the invisible hand of the market would allocate resources to everyone’s advantage.
-he argued that the selfish pursuit of profit by every individual could lead to a whole economy where benefit was maximised.
-he attacked the economic system of his day which restricted free trade through protectionism, economic restrictions and legal barriers.

Question 23

what is Adam Smith often seen as an advocate of?

Answer 23

-of a free market economy and laissez-faire government.

Question 24

What does Laissez-faire mean?

Answer 24

it means that the government should leave markets as much as possible to regulate themselves

Question 25

however, what are the points in Adam Smiths writings where he recognises that the state has an important role to play in providing a framework within which free markets can operate?

Answer 25

-he saw that individuals and firms would attempt to combine together to raise prices at the expense of the consumer.
-we wrote that employers would drive wages down as low as possible whether or not workers could survive on these incomes.
-he also argued that the state had to provide those goods and services which free markets would otherwise not provide. The whole legal and judicial framework for enforcing property law, e.g. needed to be provided by the state. So too did goods such as roads and bridges

Question 26

Who was Friedrich Hayek? what was his most famous book?

Answer 26

-he was a 20th century Austrian economist who moved to the UK in 1931
-his most famous book was: The road to serfdom

Question 27

who did Hayek’s book influence a lot?

Answer 27

Margaret Thatcher

Question 28

What did Hayek argue in his book?

Answer 28

-he argued that ever-greater control of the economy by the state leads to totalitarianism and the loss of freedom by the individual. He was reacting to the loss of the individual freedom in the Soviet Union under Stalin and Germany under Hitler
-he correctly saw that individuals were forced to comply with the state wishes through the threat of imprisonment and death. However, he then said that greater state control over the economy in both the UK and the USA also led to a loss of freedom for the individual.

Question 29

how did Hayek see the poor in the UK and the USA?

Answer 29

he saw them as better off than the poor in Germany or the Soviet Union because at least they had their personal freedom

Question 30

why have proponents of free markets used Hayek’s thoughts to argue that free unregulated markets are better than regulated markets or direct state provision and control? However, what would critics argue?

Answer 30

-because like Hayek thinks, the liberties of the individual are maintained in free markets. Hayek also said that central planning by governments led to the will of a small minority of individuals being imposed on the whole of society.
-However, critics would argue that this occurs in free market economies too. Those who own property are able to impose their will on everyone else. In a free market economy, the poor have very few ‘spending votes’ compared to the rich. In free market economies, the rich are also able to buy influence over political processes, influencing political decision making. The poor then become politically disenfranchised as well as being economically marginalised

Question 31

Who was Karl Marx?

Answer 31

he was a 19th century German thinker and writer
-his most famous book was: Das Capital
-he correctly saw that there was a great gulf between the economic fortunes of the owners of property and workers in 19th century Europe. He wanted to see that gulf eliminated.
-he developed a theory which said that it was historically inevitable that workers, the proletariat, would rise up in revolution against property owners and violently seize control of the means of production. A new democratic society would arise which would lead to equality and where property would be owned by everyone collectively

Question 32

What was the problem for Marxists?

Answer 32

it was how to go from a capitalism free market economy to a utopian economy where somehow everyone owned everything to the benefit of all.
-Joseph Stalin solved this problem by creating a command economy where the state owned most resources (which Karl Marx probably would not have approved of)