Economic Systems and Thinkers Flashcards
What are the three different types of economies
Free market
Command
Mixed
Give three economic thinkers
Marx
Smith
Hayek
What is a free market
Where all resources are allocated by markets by the three functions of the price mechanism
Explain how the price mechanism allocates resources in a free market
The price mechanism signals to and incentivizes producers to sell the goods the consumers want
It also rations resources so only the consumers that are willing to pay the most can get what they want
What happens in a free market if consumers don’t buy all the products that producer supply
There will be excess supply
Producers will drop prices and produce fewer goods - encouraging more consumers to buy which eliminates surplus
What will happen if consumers want more goods that producers are supplying in a free market
Excess demand or a shortage
Consumers will bid up the price which incentivizes and signals to producers to produce more
While rationing consumer demand to eliminate the shortage
What types of government intervention are absent in a free market
Taxes
Subsidies
State provision
Max/min price
Regulation
What is central planning
The government deciding how to allocate resources
What is a mixed economy
A mix between free markets and government intervention
What sort of market did Adam Smith love
Free markets
What did Adam Smith believe about the invisible hand
Through the three functions of the price mechanism (rationing, signalling, incentivising) he believed that the invisible hand would lead to a price equilibrium that would benefit society
What did Adam Smith believe about the price mechanism
Believed that products will be rationed to consumers that can pay the biggest price and therefore benefit the most from it
Those who produce the good will be those willing to supply at the lowest prices and therefore have the lowest costs of production
This makes sense since there resources are scarce
What was Karl Marx belief about free markets
The bourgeoisie would exploit the proliteriat until they grow sick of being exploited and rise up in a revolution
Then resources and capital would be shared among the people and the government would own all factors of production and control the allocation of resources
When did Adam Smith recognize a need for government intervention
Can only intervene when market failure happens
Explain Hayeks objection to command economies
In order for governments to allocate resources it would need information - which would be impossible for a government to acquire because of the large amount of people in a population and the fact that the opinions and wants of the population change everyday
So governments won’t be able to figure out what consumers wanted and producers will produce the wrong stuff
What are the pros of free market economies
The price mechanism is efficient in allocating resources
Lower prices - lots of producers competing against each other; forced to increase efficiency, cut costs and lower prices
Choice - constantly trying to improve their products to outdo their rivals
What are the cons of the free market
The consumers that are willing to pay the most are not necessarily the ones that benefit the most - price mechanism is not as efficient as Smith thought; can lead to inequatlity
Monopolies - can afford to put prices up because they are the only supplier and no competitors so poor customer service
Market failure -
What did Hayek say about the price mechanism
Can be seen as a communication network between producers and consumers
How can free markets lead to market failure
Free rider problem means public goods will be underprovided Goods with positive externalities will be underproduced and underconsumed and vice versa
Information gaps will lead to bad decisions
What are the pros of command economies
Can correct market failure - indirect taxes, minimum prices or with regulation; can also encourage consumption of goods that have positive externalities with subsidies or state provision
Less inequality
Stop monopoly abuse
How can command economies correct market failure
Discourage consumption of goods with negative externalities - indirect taxes, minimum prices or with regulation
Encourage consumption of goods that have positive externalities - subsidies or state provision
Public goods can be provided
Information gaps can be corrected because the government controls producers
What are the cons of command economies
Can lead to governement failure
Can destroy incentives if everyone has the same income - workers slack off meaning less productivity and entrepreneurs innovate less because there is no proft incentive
How can command economies lead to government failure
Unintended consequences - like smuggling or black markets
Information gaps mean its hard to efficiently intervene
Large administration costs to intervene
Disorts price mechanism - creates excess demand and supply
