Unit 4 : Market and Mixed Economies

Market and Mixed Economies

·         All economies have to answer 3 fundamental questions:

o   What to produce

o   How to produce it

o   Who is to receive the products produced

·         These questions arise because of The Basic economic problem: Unlimited wants exceed scarce resources

Different Economic Systems

Planned Economy

·         Aka centrally planned, command economy, collectivist economy

·         One in which the state (government) makes the crucial decisions

·         Land and capital are state owned

·         Gives instructions(directives) – resources are allocated by directives to SOEs (State Owned Enterprises)

·         Definition : A planned economy is an economy where the government makes the crucial decisions, land and capital are state-owned and resources are allocated by directives

Market Economy

·         Aka free enterprise economy

·         It is an economy where consumers determine what is produced

·         Resources are allocated by price mechanism

·         Resources switch from products that are becoming less popular to products that are becoming more popular

·         Government intervention is minimum

·         Land and capital are privately owned

·         Private firms decide how to produce the products that consumers want to buy.

·         Firms have two methods of production – capital or labour intensive

o   Capital intensive: Employs large amounts of capital relative to labour. Example : Steel firms

o   Labour intensive: Uses a relatively high number of workers in comparison with the amount of capital used. Example: Hotels.

·         Firms use the least cost method of production

·         The advantages of market economy

o   A market economy should be very expensive in consumer demand

o   Consumers are said to be sovereign

o   Choice: Consumers can choose which product from which firm

o   Efficiency: Promoted by profit motive and competition

o   Incentive: High incomes provide incentives to workers to work hard and entrepreneurs to expand firms

·         The disadvantages of market economy

o   Firms only take into account the costs and benefits to themselves. Eg: Smoking

o   Competition will result in domination by one or a few firms leading to limited choices

o   Firms may not be able to respond to desires of consumers

o   Firms will not make products unless they can charge for it

o   Advertising can distort consumer choice

o   Consumers may have a lack of income. There can be a very uneven distribution of income

·         Definition: A market economy is an economy where consumers determine what is produced, resources are allocated by price mechanism and land and capital are privately owned.

Mixed Economy

·         An economy in which both the private and public sectors play an important role

·         Both consumers and government influence what is produced

·         Benefits due to state intervention:

o   Government takes into account all the costs and benefits that will arise from their decision

o   Encourages the consumption of beneficial products by granting subsidies and providing information

o   Discourages the consumption of harmful products by imposing taxes, providing information and passing legislation

o   Can finance the production that cannot be charged for directly. Eg: Defence

o   Can prevent private sector firms from exploiting consumers by charging high prices

o   Can make maximum use of resources

o   Can plan ahead to a greater extent than private sector firms

o   Can help vulnerable groups – can create a more even distribution of income

·         Definition: A mixed economy is an economy in which both the private and public sectors play an important role.

Examples of different economic systems

·         Mixed – Sweden

·         Market – USA

·         Planned – Cuba