Economic systems 1.1.6

What is a Free Market Economy?

When economic decisions are primarily made by private individuals and firms

What are some advantages of free market economies?

• An efficient allocation of scarce resources

• Competitive prices for consumers as suppliers look to increase market share

• Competition drive innovation and invention- dynamic efficiency

• The profit motive stimulates investment which encourages economies of scale

• Competition through trade reduces domestic monopoly power

What are some disadvantages of free market economies?

• Some people may be unable to work

• De-merit goods may be over-produce

• Merit goods may not be consumed in large enough quantities

• The profit motive means firms may be tempted to cut costs and so exploit labour

• Some firms may grow so large that they gain significant monopoly power and increase prices

• Public goods won’t be provided

What is a Command Economy?

When a government or central authority makes all economic decisions

What are some advantages of central planning/ command economies?

• There is generally a low level of inequality and a low level of unemployment

• Resources are allocated according to the ‘common good’ rather than the ‘profit motive’ which is likely to result in universal provision of healthcare and education

• It may be more straightforward/ fast to get large scale infrastructure projects built

What are some disadvantages of central planning/ control economies?

• Bureaucratic costs of central planning of resources

• Problems in fixing prices of goods and services- planners are unlikely to be as accurate as the market in determining suitable prices

• Absence of incentives for both workers and (wage incentives) and businesses (no profit motive) can damage productivity and also lead to large levels of over-employment

What is a Mixed Economy?

When resources are allocated using both the market mechanism, and others by the government

Why does the government typically collect taxes in a mixed economy?

a) help ‘redistribute’ income from the rich to the poor

b) to provide the goods and services it regards as essential