Free Market Economies, Mixed Economy & Command Economy (6)

What is done in order to to solve the basic problem of scarcity ?

• Economic systems emerge or are created by different economic agents within the economy

• These agents include consumers, producers, the government, and special interest groups (e.g. environmental or trade unions)

• The economic system aims to allocate the scarce factors of production

How do economic systems decide how to answer the three fundamental economic questions ?

• Any economic system needs to decide how to answer the three fundamental economic questions

  • What to produce? More weapons for the military, or more schools to educate the children?

  • Who to produce for? Only those who can afford to pay for it? Or for everyone in society?

  • How to produce it? Should more labour be used, or should the economy focus on using technology instead?

What is a free - market economy ?

• A free-market economy is an economy that has no government intervention in the allocation of resources or the distribution of goods/services

What is a command economy?

• A command economy is an economy in which all of the resources are owned by the state and the government controls the distribution of goods/services

What is a mixed economy ?

• A mixed economy is a blend of the free market and planned economy as individuals, firms and the government own factors of production and distribute goods/services

Free markets - adam smith

• Adam Smith advocated for free markets with low levels of government intervention

• He recognised that there was a role for governments to ensure efficiencyin the allocation of resources and provide public and merit goods

• However, he believed economies function best when private individualswork in their own self-interest 

• Famous quote: "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest"

Mixed economies - Friedrick Hayek

• Friedrich Hayekbelieved that command economieswere flawed

• He identified information gaps between what the economies actually required and what the central planners in command economies were saying it required

• These gaps led to shortages or surpluses of goods/services in command economies

• He felt that thethreat to efficiency and economic growth is overly heavy government intervention

• He believed markets should play the dominant role in allocating resources, although he accepted a limited role for government

Command Economies - Karl Marx

• Karl Marx believed that free markets lead to capitalism, in which the owners of the factors of production (Capitalists) exploited the workers

• This creates inequality,which will lead to a breakdown between the classes

• The role of the State is therefore to share the means of production and ownershipwith all of the workers in society

• This required the abolition of private property

• This required the State to become the central planner, deciding how each of the three economic questions would be answered

Why is it good to know the pros and cons of these economies ?

• Each economic system has numerous advantages and disadvantages. Understanding the strengths and weakness of each system helps policymakers tackle the disadvantages head on while building on its strengths

Free market economy advantages

ADVANTAGE:

• Profit incentive motivatespeople to workor develop entrepreneurial ideas

• Greater varietyof goods/services

• Competition leads to better quality of goods/services

• Competition leads to lower prices of goods/services

• Competition encourages innovation and product development

• Profits, income and wealth are unlimited resulting in better standards of living

• More efficientuse of scarce resources

Free market economy - Disadvantages

• Wealth is concentrated in the hands of the few as they are able to keep buying up the scarce factors of production

• This increases inequalityso the gap between the rich and the poor continues to grow

• Sometimes product quality falls as firms lower quality standards in order to increase profits

• Workers get exploited

• Resource depletion and environmental degradation are often ignored

• Monopolies develop as firms increase market power through mergers and acquisitions

• This leads to exploitationof consumers and supply chains

Command economy - Advantage

• Social equality is the goal of the system as opposed to profit maximisation, so there is less inequality

• All workers receive the same wageirrespective of role or career. This helps create social equality

• Less unemployment

• Resources of the nation can be directed towards urgent priorities quickly

• The government owns monopoly businesses so consumer exploitation through high prices can be avoided

Command economy disadvantages

• Receiving the same wage creates disincentives for people to acquire difficult skills (e.g. doctor), as 8 years of study results in the same wage as no study

• A lack of competition means that there is less innovation and product development

• There is a continual lack of efficiency as central planning always results in surpluses or shortages of goods/services

• Black markets multiply as the population seeks to address shortages

• Access to higher standards of living is limited for most of the population

• Personal freedoms are restricted

Role of the state in a mixed economy

• Some mixed economies have a higher level of government intervention than others

• Government intervention occurs mainly through taxation (to raise revenue) and then spendingthe revenue to redistribute income and provide essential goods/services

  • There are many different type of tax interventions, including personal income tax, corporation tax, value added tax, tariff on imports, inheritance tax etc.

  • Income is redistributed through the creation of a welfare system, which often includes unemployment benefits, healthcare, and pension provision

  • Government spending is often focused on infrastructure, merit goods (e.g. schools) and public goods (e.g. national defence)