1.1.6 Free market economies, mixed economy and command economy

Adam smiths theory

He believed in the free market economy. He explained how there was an ‘invisible hand’ in the market which allocated resources to everyone’s advantage, allowing the greatest good for the greatest number of people.

Adam smiths contradiction

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

Hayek’s theory

He argued that state control of the economy leads to the loss of freedom. He 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

Marx theory

He believed in the command economy and criticised capitalism. He wanted to remove difference between incomes as this would create a two class system with a few wealthy capitalists and many underpaid workers.

Free market economy

Individuals are free to make their own choices and control the factors of production without government intervention. Resources were allocated through the price mechanism

Command economy

All factors of production or controlled by the state except labour which is directed by the state. There’s no private property and everyone is considered selfless, working for a common good.

Mixed economy

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

Advantages of free market economy

• The system is automatic due to invisible hand

• Consumers have freedom of choice

• High motivation as hard work leads to high reward

• There’s political freedom

Disadvantages of free market economy

• High levels of inequality

• Lack of merit goods and little control of demerit goods

• Monopolies

• Problem of externalitites

Advantages of command economy

• State provides a minimum standard of living

• Less wastage of resources

• Standardize products

• Long term planning

Disadvantages of command economy

• Decision making will be slow and could be an increase in bribery and corruption

• Less motivation and efficiency

• Consumers lose their freedom

Advantages of mixed economy

• Promote innovation to meet customer needs in best and most cost effective way

• Provide balance between individual freedom and social responsibility

• Ensure basic needs are met

• Provides a social safety net for those in need of assistance/can’t work

Disadvantages of mixed economy

• Excessive taxation

• Government monopolies

• Government overextend its role causing a crowding out of the private sector

• Political pressure may lead to inefficient allocation of resources

Governments role in mixed economy

• Use taxes to redistribute income

• Stabilize economy

• Creates a framework of rules

• Supplements and modifies the price system