1.1.6 Free market economies, mixed economy and command economy

What is a free market economy

Individuals are free to make their own choices and own the factors of production without government interference

How are resources allocated in a free market economy

Through the price mechanism => consumer determines what is produced by their willingnesses to spend their money a good

Consumers make decisions based on satisfaction and producers based on profit

what is Adam smiths ‘invisible hand’ theory

There was an ‘invisible hand’ in the market which allocated resources to everyone’s advantage => allowing the greatest good for the greater number of people

He believed competition in the market caused lower prices as firms wanted to b competitive => benefits consumers as goods are cheaper

what was Friedrich Hayek’s view on free market economy

State control of the economy leads to a loss of freedom

Believed that the poor in free market countries were better off than those in command economies => they had personal freedom

Also said 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

Eg, consumer knows how much bread they need etc.

Advantages of a free market economy

• system is automatic due to the invisible hand ; resources are moved out of production of a good => when people stop wanting it /cost are high

• Consumers have freedom of choice (consumer sovereignty)

• High motivation => people know working hard to lead to potential rewards

• Political freedom

• Firms are in competition => produce goods at lowest costs => ensures productive efficiency

• Generally, free market economies have higher growth

Disadvantages of a free market economy

• tends to be high levels of inequality => rich own more factors of production so they become richer

• Lack of merit goods (goods considered as essential goods) and little m control of demerit goods (essentially bad)

• Resources could be wasted on unproductive expenses such as advertising, switching factors of production and providing competitive services

• If competition disappears they may be monopolies => charge high prices and offer low quality of service

• Externalities problems

What is a command economy

A planned economy, all factors of production (except labour) is owned by the state and labour is directed by the state

There is no private property and everyone is assumed to work for the common good

How are resources allocated in a command economy

Resources allocation carried out by the government, rather than the price mechanism

Governments allocation may represent the wishes of the consumer => focuses on the need to expand certain areas of the economy

How is income distributed in a command economy

Determined by the government and all workers, no matter their job, tend to receive the same wage, products are standardised and prices are limited => causes excess demand and queueing

What did Karl Marx believe about command economies

Believed in command economies and criticised capitalism => believed capitalists profit came from exploiting labour (underpaid workers)

Wanted to remove the difference between the incomes of owners and workers

Thought more firms would fail because of competition causing unemployment, lower wages and higher prices => lead to discontent amongst working class

His theory stated that these workers would rise against property owners and seize control of means of production => lead to a democratic society

Advantages of command economy

• state provides a minimum living standard

• Less wastage of resources

• Long term planning means industry don’t have to keep changing and shifting resources

• Standardised products => produced cost effectively

• Government motivated by well-being of the country => merit goods are encouraged and increased whilst demerit goods aren’t produced

Disadvantages of command economy

• impossible for the state to make so many decisions correctly => lead to over or under support and waste of resources

• Decision making will be slow => has to go through various stages (chances of bribery and corruption)

• Less motivation and efficiency as receives the same wage

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

What is a mixed economy

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

Governments role in a mixed economy

• creating a framework of rules: preventing the abuse of monopolies (company with more than 25% of market share)

  protect consumers => consumer laws

  protect property rights => ensures whatever a person owns can’t be taken away by someone else

  ensure safety standards (protecting employees and employers)

• supplements and modifies the price system: they produce public and merit goods (such as services and transport)

  limit production of demerit goods

• Redistributes income: they move income from one group of people to another (from rich to poor)

  eg. Tax, such as income tax, to task away money from one group to give to the poor => in the form of benefits for those out of work or on low income

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