Advantages and disadvantages of market economy, command or planned economy and mixed economy

By | June 26, 2013

 

1.1    Market economy

 

1.1.1            Introduction of Market economy

 

Market economy refers to a system where the prices of goods and services are set by supply and demand. The value of information, goods, and services is determined through free trade (wikinvest.com 2012).

 

1.1.2            Advantages of Market economy

 

1.1.2.1      Free to buy and produce and reduced business cycle

 

One of the major benefits of market economy is that buyers are free to purchase any commodity which they like and in whatever amounts. The seller of a good or its producer can also produce whichever product they want to and also increase the capacity of any individual commodity depending upon the forces of the market. Producers are free to undertake the risks and rewards associated with increase in production. There is no state intervention in the functioning of the forces of the market (economywatch.com 2010). And the benefits by not imposing any restrictions on the market is that the customer demand would be quickly turned into products and services and in comparison under well regulated environment, the government and the relevant departments would usually impose restrictions and sanctions over the new products and which could be very inefficient. In another word, the adoption of market economy would be helpful in reducing the length of business cycle and satisfy the customer needs as quickly as possible.

 

1.1.2.2      Market price reflects the market demand and supply

 

In free market economy, market prices evolve as individuals trade units of their own private property (goods, services, money, etc.) with one another, each in response to his own personal (subjective) values. The more eager a person is to satisfy some particular need or want or goal, and the more he or she will be willing to offer for it relative to his own personal means and other needs and wants, the more he or she will value what it takes to get it. As every on of us tries to get what he or she wants, market prices appear reflecting the relationship between the market demand and supply (Greaves 2007, p. 218).

 

1.1.2.3      The link between efforts and reward

 

A clear link between efforts and reward is said to be able to enhance the work efficiency and effectiveness with the income distribution system. As we know in a free market, because the government is not playing its functions, individuals would have to do their work to earn their salary and income, because of the direct link between efforts and rewards, result oriented works would be more common and waste of resources in building up ineffective political and company hierarchy would be largely reduced.

 

1.1.3            Disadvantages of Market economy

 

According to N. Gregory Mankiw (2009, p. 11), there are two major disadvantages of free market economy which increases the necessity to have governmental interference in the market economic activities. One reason we need government is that the invisible hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy. Most important, the market economies need institutions to enforce property rights so that individuals can own and control scarce resources. For example we have to rely on government provided police and courts to enforce our rights over the things we produce; Another reason is that despite the fact that the market economy is powerful, there is chance of market failure in which a market left one its own fails to allocate resources efficiently. The most obvious form of market failure is economic crisis. Looking at the past economic crisis, given their inherently high leverage and the ease with which the risk profile of financial assets can be altered, banks and financial institutions have incentives to take on excessive risks. Ordinarily, market mechanisms would be expected to price risks correctly and thereby ensure that risk taking in the economy is at efficient levels. However, there are two factors that have impeded such efficient outcomes. First, with the repeal of most protections from the Banking Act of the 1933, the only remaining protection against risk shifting is capital requirements. The second mechanism that induces excessive risk taking is a failure of corporate governance involving shareholders and employees (adbi.org 2011). And because of the market could not be fully mature (e.g. corporate government could fail), and some business men and management of companies could put focus on the short run interest and thus take risk on the high risk investment or care only their own personal interests, market economy alone could not be efficient all the time.

 

1.2    Command or Planned economy

 

1.2.1            Introduction of Planned economy

 

A market economy is the opposite of a command or centrally planned economy. In a command system, the government determines what goods are sold, how much of them, and what they will cost. This single actor is replaced by many in a market system, where the price of a good is determined by both the supply and demand for it (wikinvest.com 2012). And in the following we will talk about the advantages and disadvantages of planned economy.

 

1.2.2            Advantages of Planned economy

 

1.2.2.1      Elimination of inflation and price fluctuations

 

In command economies, the central government stipulates what and how much of most products will be produced. By setting prices and wages the central government can also dictate how much of the production is allotted to each household. In short, the central government controls production and income in command economies (Musgrave, Harding, Kacapyr & Harding 2001, p. 37). And because of this functional feature of command economies, the price could not be determined depending on how much would be produced and how much people’s demand is, as a result, price would be stable and as a matter of fact in most planned economies, prices are set by the policy makers. Hence, one major advantage of adopting the planned economy is that it largely eliminate the appearance of inflation and price fluctuations which are usually challenges to the capitalist free market economies.

 

1.2.2.2      A powerful central government

 

1.2.3            Disadvantages of Planned economy

 

1.2.3.1      Lack of employee motivation and responsibility

 

According to Max Weber (1978, p. 110), a planned economy oriented to want satisfaction must, in proportion as it is radically carried through, weaken the incentive to labor so far as the risk of lack of support is involved. Because it would, at least so far as there is a rational system of provision for wants, be impossible to allow a worker’s dependents to suffer the full consequences of his lack of efficiency in production. This lack of labor or employee motivation and responsibility could be found in China before its famous economy reform in the 1980s. At that time, distribution of goods are depending on the labor hours and individuals were not responsible for the consequences of their works. Therefore, the labor efficiency was much lower in China. And also, as a result, technology innovations were rare because they were not motivated to do so as there would be no obvious rewards for such good performance.

 

1.3    Mixed economy

 

1.3.1            Introduction of Mixed economy

 

A mixed economy is a mixture of freedom and controls—with no principles, rules, or theories to define either. Since the introduction of controls necessitates and leads to further controls, it is an unstable, explosive mixture which, ultimately, has to repeal the controls or collapse into dictatorship. A mixed economy has no principles to define its policies, its goals, its laws—no principles to limit the power of its government. The only principle of a mixed economy is that no one’s interests are safe, everyone’s interests are on a public auction block, and anything goes for anyone who can get away with it (aynrandlexicon.com 2011).

 

1.3.2            Advantages of Mixed economy

 

1.3.2.1      Efficient allocation of resources

 

Under a mixed economy environment, both private and public sectors are keen to make efficient allocation of resources. Private sector makes efficient use of resources in order to earn more profit. Main motive of the public sector is to promote social welfare. Thus there is a sort of synthesis of social welfare and private profit. As a result, mixed economy promotes both level of economic development as well as social welfare (Jain, Trehan, M. & Trehan, R. 2010, p. 314). This advantage of efficient allocation of resources could be traced back to the adoption of the market economy mode in the mixed economy framework and as we have mentioned above, market economy has the advantage of efficient allocation of resources because of that the participants are free to supply and demand and little interference from outside the market would be imposed in most situations.

 

1.3.2.2      Multiple participating channels of individuals in shaping the

 

Because in the mixed economy, individuals can help guide the economy not only through the choices they make as consumers but through the votes they cast for officials who shape economic policy. For example, in recent years in the US, consumers have voiced concerns about product safety, environmental threats posed by certain industrial practices, and potential health risks citizens may face; government has responded by creating agencies to protect consumer interests and promote the general public welfare (U.S. Department of State 2010).

 

1.3.3            Disadvantages of Mixed economy

 

1.3.3.1      Role conflict

 

As we just said, as both the features of free market and plan economy are combined in the mixed economy, both the governments and the business firms would have a say in shaping the economic environment, and under such circumstances, there could be a possible challenge: role conflict. For example, when we are looking back on the 2008 financial crisis, the majority of us would conclude that the government should have played a more active role in preventing the happening of this crisis by restricting the high risk financial products. But the problem is, even if the US government had done this, its decisions would be suspected by the market players by over disturbing the normal market activities. It would be hard to define whether it is necessary for the government to take over some market functions during some specific times.

 

1.3.3.2      Possibility of encouraging bureaucracy

 

In a mixed economy, business is accountable to the government by many ways which become a part of the so called social responsibility. The business should pay proper taxes to the government exchequer. Again it is the responsibility of the business to follow all the rules and regulation of the government and to disclose all the material facts about the business (Saha 2009). Because of the closed relationship between the business and the government, the government would need to have powerful and comprehensive functional departments and a large public sector to handle these issues. And therefore, the mixed economy would also tend to encourage bureaucracy even though this problem may not be as serious as found in the planned economy in which the government is overwhelmingly strong. But still, the promotion of the bureaucracy in the mixed economy would increase the economy burden and contribute to some economy inefficiencies.

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