1.1.6 Free market economies, mixed economy and command economy

Question 1

What questions do different types of markets produce?

Answer 1

• What to produce?
• How to produce it?
• For whom to produce it?

Question 2

What is a free market Economy?

Answer 2

• Where individuals are free to make their own choices and own the factors of production without government interference.
• Resources are allocated through the price mechanism.
• The consumer determines what is produced by their willingness to spend their money on a good.
• Consumers make decisions based on satisfaction and producers based on profit.

Question 3

Are there completely free markets today and explain?

Answer 3

• There are no completely free markets in the world today
• Because the government has to intervene at least to an extent, for example by issuing money, protecting property rights and breaking up monopolies.

-Without this, the market mechanism could not work.

Question 4

What is a monopoly?

Answer 4

A market with the “absence of competition”, creating a situation where a specific person or enterprise is the only supplier of a particular thing.

Question 5

Summarise Adam Smith and his views.

Answer 5

• Adam Smith (1723 - 1790) believed in the free market economy and the laissez-faire approach by governments.
• 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
• He believed competition in the market caused lower prices as firms wanted to be competitive and so this benefits the consumer as they can get goods cheaply
• However, he recognised that there would be a minority of more wealthy people and a larger proportion of “poorer” labourers
• Smith warned that we should be wary of monopolies and their tendency to raise prices

Question 6

Summarise Friedrich Hayek and his views.

Answer 6

• Friedrich Hayek (1899-1992) argued that state control of the economy leads to the loss of freedom.
• He believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom.
• Also, he said that central planning by governments led to what a small minority wanted being forced on the whole of society.
• Hayek 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 i.e. a consumer knows how much bread they need and a manager knows how many raw materials they need.

Question 7

What are the advantages of a free market economy?

Answer 7

• The system is automatic due to the invisible hand; resources are moved out of production of a good when people stop wanting it or costs are too high.
• Consumers have freedom of choice, called consumer sovereignty.
• There is high motivation as people know working hard could lead to high potential rewards, creating conditions where initiative and enterprise flourish.
• There is political freedom.
• Because firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency.
• In general, freer market economies tend to have higher growth.

Question 8

What are the disadvantages of a free market economy?

Answer 8

• There tends to be high levels of inequality, since the rich own more factors of production and so can grow richer.
• There may be a lack of merit goods (goods considered as intrinsically good) and little control of demerit goods (intrinsically bad).
• Resources could be wasted on unproductive expenses such as advertising, switching the factors of production and providing competitive services.
• If competition disappears then there may be monopolies, who charge high prices and offer low quality of service.
• There is the problem of externalities.

Question 9

What is a command economy?

Answer 9

• An economy where 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 be selfless, working for a common good.
• Resource allocation is carried out by the government, rather than the price mechanism. The government’s allocation may represent the wishes of the consumer and often focuses on the need to expand certain areas of the economy, such as weapon building.
• However, planning is so complex that some decisions are left up to the consumer.
• Workers receive wages and can spend this on what they want, within limits. Some goods can be purchased whilst others, such as
  houses, are allocated.
• Income distribution is determined by the government and all workers, no matter their job, tend to receive the same wage, products are standardised and prices are limited causing excess demand and queueing.

Question 10

Summarise Karl Marx and his views.

Answer 10

• Karl Marx (1818-1883) believed in the command economy and criticised capitalism.
• Marx believed that capitalist’s profit came from exploiting labour as they underpaid workers for the value that they actually created.
• He wanted remove the difference between the incomes of
  owners and workers and believed that capitalism would collapse leading to communism.
• Marx saw businesses growing and workers getting poorer, creating a two class system with a few wealthy capitalists and many underpaid workers.
• He thought more firms would fail because of competition causing unemployment, lower wages and higher prices and this would lead to discontent amongst the working class.
• His theory stated that these workers would inevitably rise against property owners and seize control of the means of production.
• This would lead to a democratic society where everything would be owned by everyone i.e. the fall of capitalism to begin communism.

Question 11

What are the advantages of a command economy?

Answer 11

• The state provides a minimum standard of living , ensuring no one is extremely poor as there is less inequality.
• There is less wastage of resources as there is no need for competitive services nor advertising, which is very expensive.
• Long term planning means that the industry doesn’t have to keep changing and shifting resources. This is important as some industries may take a number of years to get established and would fail if planning was short term.
• Standardised products means that they are produced cost effectively.
• As the government, who are generally motivated by the wellbeing of the country, rather than the companies, who are motivated by profit, decide resource allocation, objectives other than profit can be followed: merit goods are encouraged and increased whilst demerit goods aren’t produced.

Question 12

What are the disadvantages of a command economy?

Answer 12

• It is impossible for the state to make so many decisions correctly, which could lead to over or under supply and a waste of resources.
• Decision making will be slow as it has to go through various stages and there could be an increase in bribery and corruption (an increase in bureaucracy).
• As everyone receives the same wage, there is less motivation and efficiency because people know that working harder will not increase their standard of living.
• Consumers lose their freedom and it is often led by dictators.

Question 13

What is a mixed economy?

Answer 13

• This is an economy where both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country .
• Each country will have a different amount of control by the government, but it is usually between 40-60%.

Question 14

What is the government’s role in a mixed economy?

Answer 14

• Creating a framework of roles
• Supplementing and modifying the price system
• Redistributes income
• Stabilises the economy