1.1.5 Mixed economies

Free market economy

Free market economy

An economy that has no government intervention in the allocation of resources and distribution of goods/services.

Advantages of free market economy

• Efficient allocation of scarce resources

• Encourages competition – drives down prices, improves quality and choice and reduces monopoly power

• Increases in investment and innovation

Disadvantages of free market economy (5)

• Increase in wealth and income inequality

• Lack of provision of public and merit goods (such as street lights, schools, hospitals

• Monopoly power can be achieved.

• Deregulated financial markets can cause instability

• Negative externalities of production and consumption may occur. E.g. pollution from production, many people smoking, etc. 

Planned/command economy

Here, all decisions are made by the government. They decide what to produce, how to produce and for whom to produce

Advantages of planned/command economy

• Enables economies to overcome market failure

• Reduces income inequality

• Maximises social welfare rather than profit

• Prevents abuse of monopoly power

• Ensures everyone has access to basic necessities

Disadvantages of planned/command economy

• Governments may lack information about what to produce. 

• Inefficient firms are protected and kept going.

• Price controls lead to shortages and surpluses. 

Mixed economy

gGoods and services are partly owned and run by both the private and public sectors. The majority of economies have a mixed economic system.

Public sector

Government owned and run - aims to maximise consumer welfare.

Private sector

Privately owned and run (not run by the government) - aims to maximise profits. 

Market failure

Market failure occurs when the free market fails to allocate resources effectively. E.g. education tends to be under-consumed in the free market, therefore governments either subsidise or provide free at point of use. 

Three main causes of market failure

1. Externalities - Something that is a by-product of a production process but affects a third party externally.

2. Public, merit and demerit goods - These are all types of goods where, if the government did not intervene, the market would under provide, over provide or even fail to provide at all.

3. Information problems - In the real world, buyers and sellers do not have perfect information.

Externality

Positive or negative side effects of economic activity that affect third parties who are not directly involved in the transaction.

What two things determine a public good?

Non-excludable - no single person can be restricted from the access of the good, if one person is using it it doesn’t mean that no one else could at the same time. (street-lighting is an example, everyone benefits from it at any given time)

Non-rivalrous - there is no competition with public goods because it is all regulated and comtrolled by the government

Privitisation

Tthe sale of government owned assets and industries to the private sector. 

Advantages of privatisation

• Profit incentive, improves efficiency

• Increases competition, resulting in lower prices

• The government gains money from the sale

Disadvantages of privatisation

• Firms aim to maximise profits, not welfare

• In some cases (e.g. if there is a natural monopoly) competition increases inefficiency as it can be more efficient to have just one provider of a good/service.

• Privatisation can lead to monopolies - these monopolies may need to be regulated