It was established that the basic economic problem of all societies is that of the scarcity of economic resources given unlimited wants. All societies have therefore got to respond to the economic problem by economising. Each society has to decide on what to produce given that it cannot produce all its wants at once because of the scarcity of economic resources. Wants are placed in some order of importance (scale of preference), and the more important ones are satisfied first. Market economy and command economy are two economic models that address this core issue with different approaches.
Market Economy: (Capitalist, Laissez-Faire, Liberal or Free Economy)
The pure market or capitalist economic system is one in which the production of goods and services is solely determined by market forces. There is absolutely no state interference in the functioning of the price system. Such a pure market economy has never really existed because there is always some state interference in the functioning of the economy.
In effect, a market economy is one in which there is very limited state interference in the economy. The basic economic problems are resolved by the market forces of demand and supply, the price system or the “invisible hand” as Adam Smith puts it. More formally, a market economy is characterised by:
- The right to own, control and dispose of private property such as land, buildings, etc. by individuals or groups of individuals.
- Freedom of choice and enterprise i.e. one is free to choose the production or consumption of what one likes. 15 Economic activity is dominated by self-interest or the pursuit of profit.
There is a price competition in business affairs. A limited government role in economic affairs. There is a heavy reliance on the price system for the production and distribution of goods and services.m
Price System: How the Market Economy Functions
The problem of what to produce is resolved by consumers’ preferences expressed freely in the market or by the help of the price system or price mechanism. Consumers are sovereign and the decision by a consumer to buy a given good is equivalent to casting a vote for its production.
Producers, whose aim is to maximise profits, would tend to produce those goods which are demanded(voted for) in the markets. Unlike a political election where there is ‘one man one vote’, a rich man has more ‘money ‘votes’ and so has a bigger say in helping to decide what is to be produced. On the other hand, if the consumers do not want a particular good, its price falls, producers make a loss, and factors of production leave the industry.
The problem of how to produce is resolved by the competition of different producers. The method of production which minimises costs and uses the most efficient production techniques will displace costly methods of production. This is because producers who are using less efficient methods of production will realise no profits and will be forced out of business. Efficiency is thus achieved through its effect on the size of profit. For instance, if labour becomes less expensive relative to capital, firms will possibly adopt labour-intensive methods of production. If it becomes economically efficient to produce plank by using the the engine saw, the producers using the hand saw would be forced out of business because they become less competitive.
Advantages of the Price System
- One of the main advantages of the market economy is that it is self-regulatory. It does not require a host of officials to direct resources into this or that industry for the production of this or that good, nor does it need a host of officials to distribute goods and services. The price system does it all. By so doing it may equally help to eliminate surpluses and shortages in an economy as it indicates which goods ought to be produced and which ought not to be produced as earlier explained.
- The price system working under perfect market conditions ensures economic efficiency. This is because, under such an economic system, resources are allocated such that no one can be made better off without making someone else worse off. This is demonstrated in topic 16 of this book.
- The price mechanism fulfills consumers’ choices more accurately than central planning. This is because consumer sovereignty ensures that producers only produce what consumers desire. In effect, consumers have greater freedom of choice.
- It is held that the price system has the capacity to respond more accurately to changes in the world economic environment. This is because profit maximising firms are exposed to greater competition and have to respond rapidly to changes in the relative prices of goods and raw materials. For example, the increase in oil prices in the 1970s compelled firms to use fuel more efficiently and to develop alternative means of power.
Disadvantages of the Price System
- The private profit motive may lead to the creation of negative externalities. An externality arises whenever an individual’s production or consumption decision directly affects the production or consumption of others other than through market prices. Externalities could be costs or benefits. What really concerns us here as a disadvantage is the problem of the external costs of certain productive activities. The profit-maximising soap manufacturer does not take into consideration the toxic waste which leaves his industry into the nearby rivers. It is not a cost to him but it is a cost to the community in the neighbourhood. Other negative externalities or social costs could be in the form of congestion, noise, etc.
- The price mechanism is not well equipped to produce certain goods and services whose benefits cannot be attributed to private users. In effect, the price mechanism cannot produce some vital services which are not marketable e.g defense, roads, clean air, etc. In most countries, the state now provides for such goods and services.
- In a market economy, the competition itself may sometimes lead to inefficiency. Small units of production may persist when coordination would have been vital in securing the advantages of large scale production. Competitive advertising may waste resources as firms strive to raise their sales above those of their rivals.
- Most market economies now have a very strong advertising and sales promotion media which carries out a very strong persuasive advertisement. This action actually tends to create new wants as consumers find it difficult to fully decide what is good for them. Consumers’ demand is thus distorted, leading to a substantial loss in consumer sovereignty. Professor John K. Galbraith of Havard University is one of the main protagonists of this viewpoint. Galbraith’s these is that modem firms spend vast sums of money on advertising thus manipulating market demand persuading consumers to buy what they sell, rather than producing what consumers want to buy.
Command Economy (Collectivist or Planned Economy)
Some countries have rejected the market mechanism in favor of central planning. These are the command economies in which planning committees make economic decisions.
Advantages of the Command System
Some of the disadvantages of resource allocation by the price system disappear when allocation decisions are made by the central planning committee. It is held that resource allocation by the central planning committee gives rise to the following advantages.
- A central planning committee enables a command economy to achieve full employment of economic resources like labour, land, and capital. The central planning committee directs resources into productive activities even if the activities are not profitable
- The central planning committee can easily focus on the production of basic needs because production is not intended for profit motives as in a market economy.
- There are minimum inequalities of wealth and income. This is so for the simple reason that the price system which gives room for these inequalities of wealth and income is not present.
- Negative externalities in the form of pollution, congestion, noise, etc. are negligible because the profit motive which leads private entrepreneurs to generate these costs is absent in a command economy. Even if a few external costs do arise, the central planning committee, acting in the public interest can better handle them.
- It may be possible to avoid wasteful competition as there is no profit motive in production.
- It may be possible for many firms to benefit from economies of large scale production. This is because the planning committees, unlike entrepreneurs in a market economy, can readily mobilise huge resources for large scale production.
- A command economy presents a very little likelihood for a monetary crisis of any nature to develop, especially inflation. This is so for the simple reason that a whole range of prices are administered or fixed and thus price fluctuations are minimal. If for instance, the central planning committee under produces a certain good, shortages would lead to the appearance of long queues, black markets or rationing and perhaps social unrest. If it were in a market economy, the underproduction would lead to an increase in price and eventually to an increase in the production of the good in question as required.
Disadvantages of the Comand System
Many criticisms have been leveled against the command economy and against centralized m decision making as a means of allocating resources.
- There is a great likelihood in a command economy that production will not satisfy consumers real wan This is because what is produced is decided upon by the central planning committee, which may implement what the people really want. Also, the grows produced tend to be standardized, with practically n regard for individual tastes.
- There is reduced consumer sovereignty becaus the central planning committee basically decides for consumers what has to be produced or what the should consume. This is more or less like a father deciding for his small child.
- The absence of price signals to allocate resources as in a market economy may result in shortages and surpluses of certain goods and services. This is because the central planning Committee may no accurately estimate demand. For instance, in the former Soviet Union and in 1989, much of a bumper harvest rotted on the farms because of a shortage of storage and transportation facilities, and for years there was an ample supply of black and white television sets and severe shortages of toilet paper and soap.
- A lot of costs are incurred in gathering information and working out what should be produced, how it should be produced and distributed. In contrast, the device of casting money “votes” is a costless way of doing the very job. There is indeed a loss or forgone output for those administrators in a command economy who could have been engaged in some productive activity if the price system were to do the job for them.
- There are very few incentives in the production process. This is because the profit motive is absent and workers do not get the full benefits of their productive activities. People may equally have no incentive to work because they are dissatisfied with their allotted jobs.
- In a command economy, there could be disturbing lags in the implementation of plans. There is a time- lag between the collection of information and the formulation of production plans based on such information.
Which Economic Model Is Better?
Once individuals have given power to the state to prescribe what is good for them, to own all the factors of production and to direct labour, it may not be long before the state has usurped absolute political power in addition to its economic power and the people are at the mercy of a dictatorship. Individuals then exist for the state, and not the state for the individuals.
Thus the extreme decision as to whether a market economy is to be preferred to a command economy (in their extreme forms) really hinges on the question whether you are prepared to run the risk of being ruled by a dictator or whether you would rather be left free to choose your own job, accepting such defects of the private enterprise system as inadequate provision for future production, and the existence of wide variations in wealth.
This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.
© 2020 Amazing Goal
Amazing Goal (author) from United state of American on March 15, 2020:
JC Scull from Gainesville, Florida on March 15, 2020: