Knowt
1e. Economic systems and thinkers
Free Market Economies
Advantages | Disadvantages |
|---|---|
The profit motive and competition could lead to lower prices and the creation of new products | Consumers may not have enough information to make choices or may act irrationally e.g. smoking |
Consumers have the freedom to buy and work for who they want | System prone to ‘boom and bust’ e.g. Financial Crisis |
The invisible hand will ensure the right quantities of goods and services are produced | Over provision of ‘negative externalities’ e.g. pollution |
Incentive for labour to work hard | Under provision of ‘positive externalities’ e.g. education |
Potential exploitation of workers and consumers by monopolies | |
High levels of inequality | |
No provision of public goods e.g. street lights |
Command Economies
Advantages | Disadvantages |
|---|---|
Greater income equality as resources are distributed by the government | Without the profit incentive, there is less need for the government to create new products |
Externalities should be eliminated as the government considers the total benefits and costs to society | High levels of bureaucracy |
With one producer there should be increased efficiency through economies of scale (e.g. London Underground) | The government may not have enough information to know what consumers need |
Consumers have little economic freedom and choice | |
Prices are often kept low leading to shortages and queues |
The role of Government in an Economy
Promote competition by breaking up monopolies
Directly running industries (nationalisation) as they are public goods or can’t be provided efficiently or equitably by the free market
Protecting consumers through price caps
Protecting producers and workers through minimum prices/wages/tariffs/quotas
Ensure consumers are well informed through information provision
Nudge consumers to make rational decisions
Redistributing income through progressive taxation and transfer payments
Regulations/permits/taxes to ensure that negative externalities are eliminated
Subsidies to make products more affordable, support producers or encourage positive externalities
Keep inflation under control through the use of monetary policy
Reduce the effects of boom and bust through discretionary spending/taxation and automatic stabilisers
Enforce contracts and property rights
The Public sector
The public sector refers to any service or industry owned by the state, for example:
National Health Service
Emergency services
Armed forces
State education
Advantages | Disadvantages |
|---|---|
JOBS - Usually protected, reducing | |
unemployment. | HIGHER COSTS - Providing these services means higher costs and higher taxes. |
RESOURCES - Key supplies, e.g. water and energy, can be guaranteed and controlled. | INEFFICIENCY - Large non-profit making |
organisations suffer from diseconomies of | |
scale. | |
ESSENTIAL SERVICES - Health, education, housing, and transport are guaranteed for everyone. | GOVERNMENT INTERFERENCE - Politicians' |
interference can negatively affect the | |
efficiency of an organisation |
The Private Sector
In the private sector, most businesses are sole traders, partnerships, or limited companies (see Sole traders and partnerships and Limited Companies). Other types of ownership include franchises and co-operatives.
Advantages | Disadvantages |
|---|---|
Competition should lead to lower prices and better quality goods | Desire to increase profits might mean |
lowering wages and quality as much as | |
possible | |
Profit incentive means people might work | |
harder | Unequal access to essential services |
Government can distinguish between | |
income and corporation tax | Increase in all types of inequality |
The government might be able to lower taxes if essential services are funded by individuals | |
High profits could mean more research and | |
development and therefore improved goods |
Free Market | Command | Mixed | |
|---|---|---|---|
Resources owned by: | Individuals | State | State & individuals |
Who decides what is | |||
made? | Consumers decide indirectly – prices act as a signal | State decides | The state provides necessary services, private sector meets consumer wants |
How is it made? | Most efficient means of production in order to minimise costs and maximise profit | State plan based on inputs (available resources) and desired outputs | Combined public and |
private sectors | |||
For whom is it made? | Return to owners of | ||
factors of production | Everyone benefits equally | Incentives for owners of factors and transfer payments for poor |
Why are most economies mixed?
A command economy leads to inefficient production, less choice and innovation
A free market system leads to inequality, exploitation, pollution and a lack of essential services
A mixed economy has the best elements of both
Economic thinkers
Economist | Favoured System |
|---|---|
Adam Smith | Free-Market/MixedThe invisible hand of supply and demand guides the market to an efficient outcome. However, this relies on no monopolies so the government needs to ensure there are low barriers to entry as well as other interventions to correct market failure. |
Karl Marx | Command EconomyCapitalist societies exploit workers and are unstable so a communist system is preferable. |
Friedrich Hayek | Free-MarketDue to the complexity of economic production the free market should provide all goods except public goods |
John Maynard | |
Keynes | MixedThe free market is needed to allocate goods and services but the government needs to intervene to steer the economy. |
1e. Economic systems and thinkers
Free Market Economies
Advantages | Disadvantages |
|---|---|
The profit motive and competition could lead to lower prices and the creation of new products | Consumers may not have enough information to make choices or may act irrationally e.g. smoking |
Consumers have the freedom to buy and work for who they want | System prone to ‘boom and bust’ e.g. Financial Crisis |
The invisible hand will ensure the right quantities of goods and services are produced | Over provision of ‘negative externalities’ e.g. pollution |
Incentive for labour to work hard | Under provision of ‘positive externalities’ e.g. education |
Potential exploitation of workers and consumers by monopolies | |
High levels of inequality | |
No provision of public goods e.g. street lights |
Command Economies
Advantages | Disadvantages |
|---|---|
Greater income equality as resources are distributed by the government | Without the profit incentive, there is less need for the government to create new products |
Externalities should be eliminated as the government considers the total benefits and costs to society | High levels of bureaucracy |
With one producer there should be increased efficiency through economies of scale (e.g. London Underground) | The government may not have enough information to know what consumers need |
Consumers have little economic freedom and choice | |
Prices are often kept low leading to shortages and queues |
The role of Government in an Economy
Promote competition by breaking up monopolies
Directly running industries (nationalisation) as they are public goods or can’t be provided efficiently or equitably by the free market
Protecting consumers through price caps
Protecting producers and workers through minimum prices/wages/tariffs/quotas
Ensure consumers are well informed through information provision
Nudge consumers to make rational decisions
Redistributing income through progressive taxation and transfer payments
Regulations/permits/taxes to ensure that negative externalities are eliminated
Subsidies to make products more affordable, support producers or encourage positive externalities
Keep inflation under control through the use of monetary policy
Reduce the effects of boom and bust through discretionary spending/taxation and automatic stabilisers
Enforce contracts and property rights
The Public sector
The public sector refers to any service or industry owned by the state, for example:
National Health Service
Emergency services
Armed forces
State education
Advantages | Disadvantages |
|---|---|
JOBS - Usually protected, reducing | |
unemployment. | HIGHER COSTS - Providing these services means higher costs and higher taxes. |
RESOURCES - Key supplies, e.g. water and energy, can be guaranteed and controlled. | INEFFICIENCY - Large non-profit making |
organisations suffer from diseconomies of | |
scale. | |
ESSENTIAL SERVICES - Health, education, housing, and transport are guaranteed for everyone. | GOVERNMENT INTERFERENCE - Politicians' |
interference can negatively affect the | |
efficiency of an organisation |
The Private Sector
In the private sector, most businesses are sole traders, partnerships, or limited companies (see Sole traders and partnerships and Limited Companies). Other types of ownership include franchises and co-operatives.
Advantages | Disadvantages |
|---|---|
Competition should lead to lower prices and better quality goods | Desire to increase profits might mean |
lowering wages and quality as much as | |
possible | |
Profit incentive means people might work | |
harder | Unequal access to essential services |
Government can distinguish between | |
income and corporation tax | Increase in all types of inequality |
The government might be able to lower taxes if essential services are funded by individuals | |
High profits could mean more research and | |
development and therefore improved goods |
Free Market | Command | Mixed | |
|---|---|---|---|
Resources owned by: | Individuals | State | State & individuals |
Who decides what is | |||
made? | Consumers decide indirectly – prices act as a signal | State decides | The state provides necessary services, private sector meets consumer wants |
How is it made? | Most efficient means of production in order to minimise costs and maximise profit | State plan based on inputs (available resources) and desired outputs | Combined public and |
private sectors | |||
For whom is it made? | Return to owners of | ||
factors of production | Everyone benefits equally | Incentives for owners of factors and transfer payments for poor |
Why are most economies mixed?
A command economy leads to inefficient production, less choice and innovation
A free market system leads to inequality, exploitation, pollution and a lack of essential services
A mixed economy has the best elements of both
Economic thinkers
Economist | Favoured System |
|---|---|
Adam Smith | Free-Market/MixedThe invisible hand of supply and demand guides the market to an efficient outcome. However, this relies on no monopolies so the government needs to ensure there are low barriers to entry as well as other interventions to correct market failure. |
Karl Marx | Command EconomyCapitalist societies exploit workers and are unstable so a communist system is preferable. |
Friedrich Hayek | Free-MarketDue to the complexity of economic production the free market should provide all goods except public goods |
John Maynard | |
Keynes | MixedThe free market is needed to allocate goods and services but the government needs to intervene to steer the economy. |
