Free Economy or Planned Economy

Planned or Free Market?

Markets

There are 3 fundamental types of markets the free market; which is based entirely on the ability to pay and is controlled by the price mechanism, the mixed economy (what most present economies are) where there is a private sector based on the price mechanism but also a public sector (welfare state) that provides a safety net to the poor and the third market being a Planned Economy (or centrally planned) which is based on state rationing.

Free Markets

A free market economy is a market without any government intervention or regulation (laissez faire). There is absolutely no public sector and everything is in private control. All of the countries factors of production are privately owned (except Labour but there is no one working for the public sector so in effect the private sector does own Labour).

Everyone in the system is out to make as much money for themselves as possible; this is known as the Profit Incentive/Motive. People want to make as much profit for themselves as possible, and so try and make products as cheaply as possible. Because of this the process is also very efficient, because any waste is a waste of potential profit.

There is no state monopolies thus increasing competition amongst private firms. There are also very few monopolies in the private sector, because if a sector is profitable enough there should always be new entrants posing competition. Even if there were a monopoly, it wouldn’t be able to increase its price much more than costs otherwise new firms would be established to offer the goods or services cheaper.

Because of the threat of competition, prices are usually as low as possible, and so the profit margin would be small. Consumers have consumer sovereignty; because they decide what they buy they are in charge. If they think a product is too expensive they would buy an alternative. This would send a signal to the maker of the expensive product that people don’t want the product because they think it is too expensive, as they aren’t therefore making money on it they will reduce the prices so consumers would switch back. In the end consumers get the best possible prices.

The signals that are sent are known as the price mechanism. The price mechanism is where if demand for something is low, then prices will have to be reduced because there is excess supply. If the price is reduced there will be less incentive for someone to supply a good and therefore supply will fall. Conversely if a product is popular (maybe because of good quality or a cheap price) then there will be excess demand, which will drive prices up. Higher prices incentivise suppliers to produce more to quench the demand.

The 3 Central Economic Questions

What should be produced – is determined through the price mechanism and is ultimately determined by the consumers and what they want to consume.

How should it be produced – is the most efficient way so as to increase the profit margin of suppliers.

For whom should it be produced for – whoever has the ability to pay; those with the most money can have as much produce as they wish.

A Command Economy

Is the opposite of a Free Market Economy and is where the government or state owns all the factors of production. Everyone is paid the same wages and everyone works for the government doing what they are told. There is little opportunity for entrepreneurs to set up in business and there is little competition. This results in a lot of inefficiency because the resources are owned by the government; workers wouldn’t really care about wasting them and wouldn’t try to implement efficient methods of production.

Also there would be no profit incentive as everyone is earning the same, this would result in people doing the bare minimum and so there is little economic growth and there is high inefficiency. However there is a safety net for people, most people can easily get a job from the state, and if one isn’t able to work they still get a wage and so can pay for food.

The 3 Central Economic Questions

What should be produced – is determined by the state through planning, they determine what people are likely to need, but are often wrong.

How should it be produced – by state production, which is usually inefficient as there is no incentive to become efficient.

For whom should it be produced for – everyone gets a certain amount therefore society is fairer.

Questions

1. Name 3 planned economies

2. Name a free market economy

3. Name 3 mixed economies

Answers

Page last updated on 20/10/13