1.1.6 Types of Economies

• Free market economies are also known as laissez-faire economies.
• Free market economies are where governments leave markets to their own devices and do not intervene in the economy.
• In a free market economy market forces of supply and demand allocate scarce resources.
• In a free market economy economic decisions are made by private individuals or firms, with private individuals owning everything.
• In reality in a free market, the government usually intervenes by implementing laws and public services.
• Adam Smith’s theory of the invisible hand can be applied to free market economy and price mechanism, which describes how prices are determined by the ‘spending votes‘ of consumers and businesses.
• Friedrich Hayek argued for free market economies, believing that government intervention made the market worse.
• Decisions in a free market economy

  1. What to produce - what the consumer prefers.
  2. How to produce it - how producers will generate profit.
  3. Who to produce it for - whoever has the greatest purchasing power in the economy.
• Advantages of Command Economies

  1. Easier to coordinate resources during a crisis.
  2. Government can compensate for market failure by reallocating resources.
  3. Reduction in societal inequality.
  4. Prevention of the abuse of monopoly power.
• Disadvantages of Command Economies

  1. Governments and markets fail due to information gaps.
  2. May not meet consumer preferences.
  3. Limits democracy and personal freedom.
• Advantages of Free Market Economies

  1. Increase in efficiency - lower average costs and higher output.
  2. Bureaucracy avoided.
  3. More personal freedom.
• Disadvantages of Free Market Economies

  1. Income inequality - no social security payments.
  2. Monopolies could exploit the market with high prices.
  3. Overconsumption of demerit goods (e.g., tobacco) causing negative externalities.
  4. Public goods are not provided and merit goods are under provided (e.g., education)
• A command economy is where the governemnt allocates all scarce resources to where they think is in the greatest need.
• Karl Marx saw the free market as unstable believing the profits came from the exploitation of labour. He argued for command economies.
• Decisions in Command Economies

  1. What to produce - what the government prefers.
  2. How to produce it - governments and their employees.
  3. Who to produce it for - who the government prefers.
• A mixed economy has features of command and free economies and is the most common economic system.
• A mixed economy market is controlled by both the government and forces of supply and demand.
• In a mixed economy governments often provide public goods and merit goods.
• Decisions in Mixed Economies

  1. What to produce - determined by consumers and governments.
  2. How to produce it - determined by producers and governments.
  3. Who to produce it for - Government preferences and purchasing power of individuals.