Today, we will talk about the three answers to the three questions we posed in the last post: what to produce, how to produce, and how to distribute.
There are two answers to this question: market and command economies.
Market EconomiesMarket economies are economies where price determines the distribution and production of resources via the price mechanism.
As demand for a product rises, consumers would be more likely to pay more for the product in question in order to get it (much like an auction).
As a result, the three features of the price mechanism come into action:
1. It signals firms to increase the output of the product demanded as the higher price signals that consumers demand the good.
2. It provides firms with the incentive to produce the demanded product as they would gain a higher profit by doing so, attracting new firms into the market.
3. It rations the product to the consumers who demand the product the most and have the means to purchase it.
As a result, the amount of product supplied has increased, satisfying the demands of consumers.
Command EconomiesCommand economies are economies where a central committee decides what resources are produced and where do they go.
When you think of command economies, you would think of bread lines, long queues, and free stuff.
In command economies, all factors of production are under the control of the government.
Mixed EconomiesMixed economies are economies with both public (government-controlled) and private (firm-controlled) sectors.
They are basically what happens when a command and market economy mix.
The degree to which private and public sectors influence a country's economy varies, as some governments have a greater influence on the economy than others.
This leads to the advantages and disadvantages of the two models of the economy:
Advantages of a Market Economy- It is allocatively efficient: Instead of a bunch of bureaucrats deciding what gets produced without thorough knowledge about the wants and needs of the economy, buyers and sellers can communicate with each other via prices, ensuring that resources are distributed efficiently.
- It is productively efficient as it can be argued that firms are incentivized to maximize the output they produce to reduce costs and increase profits.
- These advantages lead to more choices as this can help firms increase their profits via product differentiation.
Disadvantages of a Market Economy- It is impersonal: it only considers the ability to pay for and desire for products, leaving those who may need but don't have the money to buy without them to negative consequences like starvation as there is no government intervention.
- The market doesn't care about anything beyond the costs, profits, and benefits that are received from products. As a result, there would be decreased welfare in the economy as society has to suffer the negative consequences that result from the wrong amount of a particular product being consumed and produced.
- Firms with influence on the market are able to exploit it to maximize the profits they make via the rise in prices like what Pfizer did with epilepsy medicine, which may lead to consumers not accessing as much product as they would like.
Note that the inverse is also true for command economies.
Next time we will be talking about what happens when the three major economic questions are answered poorly by the economy, and how it can remedy the resulting consequences.
See you next time!
