Economic systems

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Economic systems

Market-based economic systems have many advantages in comparison with command-based ones. These include:

Consumer sovereignty

Resources are allocated towards the satisfaction of the consumer, who is 'king' (sovereign) - firms can only survive if they consistently satisfy consumer demand. The more they satisfy the consumer, the greater their profits.

Choice

Firms may compete with each by offering different products, providing consumers with a wide choice.

Price and non-price competition

Competition keeps prices down and drives up the quality of goods and services.

Automatic adjustment

The price mechanism works automatically, as prices convey information about relative scarcity without the need for a government.

Rationing

Prices fulfill a vital role in terms of rationing scarce resources - the greater the scarcity, the higher the price, and the more it is conserved.

Utility and profit

The price mechanism allocates resources towards products that provide the highest utility and the greatest profit, hence benefiting consumers and producers.

Efficiency

All participants have incentives to be at their most efficient. The production of goods is efficient because firms need to keep costs as low as possible.

There is a considerable incentive for the owners of factors of production to be as efficient as they can be so that they can command the highest incomes.

Innovation

Firms usually need to innovate to retain consumer loyalty and win new customers from rivals.

The disadvantages of market-based systems

However, market systems have disadvantages, including:

Under-valuing non-traded services

Some goods and services cannot easily be traded in markets, such as healthcare, education, and defence. With these goods, the value attached by market forces is unlikely to be the 'real' value of the service.

Missing markets

There is the problem of missing markets, which arises when consumers have a need or a want but where no firms are able to enter the market to supply, and markets do not form, as in the case of public goods.

Incomplete markets

There is also the problem of incomplete markets, which arises when firms only supply a part of the whole market demand, such as the case of merit goods.

Externalities

Some goods and services generate costs and benefits that are not taken account by consumers and producers. These costs and benefits are called externalities.

Lack of purchasing power

Some consumers have no purchasing power, such as the disabled, because they are not able to work in the labour market. Without work, they cannot derive an income, and are unable to purchase goods and services.

The case for mixed economies

Mixed economies combine aspects of market systems and central planning. It is accepted that mixed economies provide a more optimal allocation of scarce resources because:

  1. Markets can be used to allocate resources to producing goods and services in which they excel, such as private consumer goods like cars, computers and holidays.

  2. Planning can be used to allocate resources to those goods and services that markets fail to produce sufficiently, such as education and policing – and solve the problem of missing and incomplete markets.

  3. Governments can regulate markets to ensure that they work effectively in the interests of consumers.

  4. Governments can allocate resources towards the unemployed, and provide a basic purchasing power, via a benefits system, to the disabled and others who cannot sell their labour.

 


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