1.1.6 Free market economies, mixed economy and command economy

FREE MARKET ECONOMY

• economy that has no government intervention in the allocation of resources or the distribution of goods/services

• individuals own the factors of production without government interference

• resources are allocated through the price mechanism

• consumers make decisions based on satisfaction and producers based on profit

• there are no completely free markets in the world today , because the government has to intervene at least to an extent, for example by issuing money, protecting property rights and breaking up monopolies- w/out this, the market mechanism could not work

ADAM SMITH

• believed in the free market economy and the laissez-faire approach by governments

• explained how there was an ‘invisible hand’ in the market which allocated resources to everyone’s advantage

• 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

• did argue that the state needed to provide goods and services which free markets wouldn’t such as. the laws, property rights and goods such as bridges and roads

FRIEDRICH HAYEK

• argued that state control of the economy leads to the loss of freedom

• believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom

• said that central planning by governments led to what a small minority wanted being forced on the whole of society

• 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

FREE MARKET- ADVANTAGES

• the system is automatic due to the invisible hand; resources are moved out of production of a good when people stop wanting it or costs are too high

• high motivation as people know working hard could lead to high potential rewards, creating conditions where initiative and enterprise flourish

• political freedom

• bc firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency

• efficient allocation of scarce resources- resources go towards where the expected profit is highest

FREE MARKET- DISADVANTAGES

• high levels of inequality, since the rich own more factors of production and so can grow richer

• a lack of merit goods (goods considered as intrinsically good) such as health and education- leads to a lower level of social welfare

• Resources could be wasted on unproductive 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 leading to an unsustainable economic growth

COMMAND ECONOMY

• all factors of production, except labour, is owned by the state and labour is directed by the state

• no private property and everyone is assumed to be selfless, working for a common good

• Resource allocation is carried out by gov- represents best wishes of consumers

• planning is so complex that some decisions are left up to the consumers- workers receive wages and can spend this on what they want, within limits

• some goods can be purchased whilst others, such as houses, are allocated

• Income distribution is determined by the government and all workers tend to receive the same wage, products are standardised and prices are limited causing excess demand

KARL MARX

• believed in the command economy and criticised capitalism

• believed that capitalist’s profit came from exploiting labour as they underpaid workers

• saw businesses growing and workers getting poorer, creating a two class system

• 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

• stated that these workers would inevitably rise against property owners

• would lead to a democratic society where everything would be owned by everyone-the fall of capitalism to begin communism

COMMAND ECONOMY- ADVANTAGES

• state provides a minimum standard of living , ensuring no one is extremely poor as there is less inequality

• less wastage of resources as there is 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- important as some industries may take a number of years to get established and would fail if planning was short term

• Standardised products means that they are produced cost effectively

• generally motivated by the wellbeing of the country, rather than the companies, who are motivated by profit, decide resource allocation, objectives other than profit can be followed: merit goods are encouraged and increased whilst demerit goods aren’t produced

COMMAND ECONOMY- DISADVANTAGES

• impossible for the state to make so many decisions correctly, which could lead to over or under supply and a waste of resources

• decision making will be slow as it has to go through various stages and there could be an increase in bribery and corruption

• as everyone receives the same wage, there is less motivation and efficiency because people know that working harder will not increase their standard of living

• consumers lose their freedom and it is often led by dictators

MIXED ECONOMY

• both types of economies have benefits but also major problems so most economies have tried to move towards some form of compromise economy

• both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country

• each country will have a different amount of control by the government, but it is usually between 40-60%

GOV’S ROLE IN A MIXED ECON (R)

CREATING A FRAMEWORK OF RULES

• prevent the abuse of monopolies: a company with more than 25% of market share

• They can protect customers as they pass a large amount of consumer protection laws to protect the consumers from poor quality products or services

• protect property rights

• ensure safety standards

GOV’S ROLE IN A MIXED ECON (PS)

SUPPLEMENTS AND MODIEIFES THE PRICE SYSTEM

• produce public and merit goods, such as emergency services and transport, and limit the production of demerit goods

GOV’S ROLE IN A MIXED ECON (RI)

REDISTRIBUTES INCOME

• move income from one group of people to another, from the rich to the poor

• use tax, such as income tax, to take money away from one group then give the money to the poor- in the form of benefits for those who are out of work or on low incomes, and in the provision of services for all, such as education and the NHS

GOV’S ROLE IN A MIXED ECON (S)

STABILISES THE ECONOMY

• government will attempt to manage the level of demand in the economy to prevent extremes of too much or too little demand