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Free Market Economies Types of Economies Mr O’Grady
Free Market Economies Definition: In a free market the fundamental economic choices of what to produce, how to produce and for whom to produce is solved by market forces (Supply & Demand) Workings: The forces of supply and demand work together to determine what price and quantity of goods and services are traded. The Market Mechanism. Customers will demand what is supplied if it is at a price that they can afford (What) Businesses will supply what is demanded at a price that allows them to make a profit (How) The Wealth of individuals will determine how much and of what they consume (For Whom) Free market stakeholders (with an interest or concern): Consumers act to maximise their personal welfare Producers act to maximise their profits Owners of Fo. P act to maximise personal gain (wages, rents, dividends, interest) Government’s act to maximise benefits to society (limited government intervention) Examples: USA, Hong Kong, Singapore
Classical Economics The Invisible Hand (Adam Smith): The self regulating behaviour of the free market Individuals seeking to maximise personal gains will lead to an efficient allocation of resources This self-interest benefits society as a whole “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. ” Limited Government Intervention (Friedrich Hayek): the state shouldn’t interfere in the free market and that its role should be to maintain the rule of law Reasoning: too much central planning of economic activity eventually led to totalitarian rule with a one party government restricting freedom and undermining democracy He advocated decentralisation and decision making be left with individuals and groups of individuals e. g. businesses The state’s role should just be as a ‘safety net’ such as social insurance e. g. National Health Service to support workers in times of need e. g. unemployment Too much government intervention makes problems worse and distorts the smooth running of the free market mechanism.
Classical economics: suggests a laissez-faire (to leave alone) approach by the government towards markets. This will provide the greatest good for the greatest number of people. “Let the market decide!” Advantages and Disadvantages Advantages Disadvantages Competitive market Inequalities in wealth Consumer choice Limited regulation Rewards entrepreneurship Provision of demerit goods Encourages innovation Little control of negative externalities Productive efficiency Economic growth
Command Economies Types of Economies Mr O’Grady
Command Economies Definition: Where resources are owned by the state and allocated by government planners in order to achieve output targets and an equal distribution of resources Workings: The state decides what, how and for whom to produce Examples: Cuba, the USSR, 20 th century China Marxism (Karl Marx): Believed labour was exploited by capitalists, the owners of the means of production e. g. factories. Marx suggested that labour was underpaid by the owners of businesses which enabled them to make profits. The inevitable inequality & exploitation that results creates a historically unavoidable class struggle To escape, there needed to be a formation of a socialist government, eventually creating a communist utopia ‘Workers of the World, Unite! You have nothing to lose but your chains’
Advantages and Disadvantages Advantages Lack of profit motive A fairer distribution of income and No competitive pressure on price wealth equality of consumption of G&S Provision of merit goods & public goods avoiding market failure Control of negative externalities through strict regulation (productive inefficiency)or quality Lack consumer sovereignty = G&S desired by citizens not necessarily produced Lack of rewards for entrepreneurship rewards, which discourages innovation and lessens LT economic growth Inability to centrally plan all the complexities of human needs and wants missing markets / government failure
Mixed Economies Types of Economies Mr O’Grady
Mixed Economies Definition: Resources are allocated by a combination of both the market mechanism (free market) and the government (command economy) Workings: Enterprise is encouraged and markets are mostly free to answer the three fundamental choices (What, How, For Whom), but government will act to: Reduce negative externalities and demerit good e. g. pollution & smoking Provide public goods & merit goods e. g. infrastructure and defence Control macroeconomic variables e. g. inflation Provide a legal framework e. g. intellectual property rights Encourage free trade e. g. restrict monopoly power and reduce consumer exploitation Examples: UK, France, Germany Keynesian Economics (John Maynard Keynes): Keynes question the idea that the free market would automatically correct itself to achieve maximum welfare. In particular, he that periods of high unemployment would persist for a long time as workers are inflexible with regards to taking a pay cut. Thus the government has a role to control markets to ensure maximum welfare as the market won’t achieve this by itself.
Advantages and Disadvantages Advantages Heavy taxes to fund public sector reduce State provides the essential incentives to work hard or make profits services for all Public sector provision is less efficient Profit motive in private sector than private sector encourages growth Competition keeps prices low and maintains consumer choice Wage differentials increase productivity Inefficient business behavior controlled Excessive control over business activity can add costs and discourage enterprise
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