Free Market vs Planned Economy

Last Updated: 26 Mar 2021
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A market economy is an economic system where the factors of production, are privately owned, consumers and producers are motivated by self interest, the level of competition in the markets is very high and resources are allocated through the price mechanism. The definition is supported by Lipsey (1992) who also state that decisions about resources allocation are made without any central direction but instead as a result of innumerable independent decision taken by individual producers & consumers hence in the market economy the individuals or market makes the ultimate decision in allocation of resources.

Whereas the planned economy is one in which the coordination of economic activity so essential to the viability and functioning of a complex social economy is undertaken through administrative means commands, directives, targets and regulations rather than by market mechanism. The dictionary. com defined this economic system as a socialist economic system in which production and distribution of goods and services are controlled by the government and industry is mostly publicly owned.

Provision of public goods

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These are goods that are non rivalry in consumption and non excludability as alluded by Stanlake (2000) He also added the examples of public goods which includes national defences, the police service, flood control schemes, street lighting, pavements and public drainage hence they often have large external benefits relative to private benefits. In a market economy, production of public goods will not be provided or is limited because producers cannot withhold the goods for non –payment since there is no way of measuring how much a person consumes, there is no basis for establishing a market price.

However in a planned economy there is provision of such goods because the government makes all decisions on what is produced. Hall (2010) mentioned that public goods cannot be provided privately because of their non diminishability and non –excludability that is consumers take a free ride since no one can be excluded from consuming them so it is almost impossible for a private firm to get anyone to pay for a public good.

In a planned economy the state can finance the provision of public goods like defence and police service, by means of taxation and sometimes borrowing, local authorities provide street lighting and flood control can be provided by giving contracts to private sector firms. Production and consumption of merit and demerit goods According to Lipsey (1992), merit goods are those goods that the government compels or encourages people to consume, mainly because individuals are said to be unaware of the true benefits from consuming them.

He also added that demerits goods are those goods which the state forbids people to consume mainly because individual are said to be unaware of the true harm they would suffer by consuming them. The best known examples of merit goods are health, education systems, insurance, inoculation and seat belts. The provision of merit goods in a free market economy tent to be under provided because spending on merit goods by the consumer would be determined by the private benefits derived from them.

Like in United State of America where the free market is practised, the public health system compromised, people are advised to buy health insurance. The poor might not be able to afford this and some people might simply decide not to bother if they feel particularly health. In cases of seat belts consumers may fail to recognise their true private benefits hence less demand and less supply in a free economy. The demerit goods include cigarettes, alcohol and illegal drugs. These are over consumed in a market system because consumers may be unaware of the true cost of consuming them which includes negative externalities.

As highlighted by Hall (2010) a planned economy there is an increase in the production and consumption of merit goods because the government considers them to be highly desirable for the welfare of the citizens. In this economic system the government has central authority to make decisions on the commodities to be produced hence emphasis will be placed on the production of merit goods and consumption of demerits will be reduced. The state can increase the production of merit goods by providing free state education and national health services.

Contracts for services like refuse collection can be given to private sector firms. The government can also encourage the consumption of merit goods by providing information about the benefits of inoculation and passing legislation requiring vehicles to take and pass the vehicle inspection tests. In the command economy production and consumption of demerit goods is reduced with the purpose of reducing health problems for the economy. The government achieve this by taxing cigarettes and alcohol heavily and ban all dangerous drugs to prevent consumption. As well as roviding information about their harmful effects to the consumers. Consumer sovereignty Lipsey (1992:84) state that “market allocation are sometimes said to demonstrate consumer sovereignty that is to imply that the consumer is king and decides what shall be produced” This was supported by Stanlake (2000)who stipulates that the freedom of consumer choice is usually held to be the most important in the free economy. It can be deduced that the consumer has the control, only the products that the consumer wants are produced. The more competitive the market structure, the more power the consumer will have.

There is a higher level of consumer sovereignty in market economy than in planned economies. The government estimates the type of products it considers the individuals to want whilst in market economies producers are motivate by profit thus they have the incentives to respond quickly to change in consumer preferences. In a free market economy consumers benefit from lower cost goods and better services because business are forced to compete whilst in a planned economy there is no competition since the government is the only supplier.

Equity in income distribution Equity is regarded as fairness. The market economy provides opportunities for people to earn income and acquire wealth but the opportunities for earning an income are no equally distribute. People do not have equal opportunities in education. Some are also limited in their capacity to learn or they may have acquired a skill only to find the demand for that skill is declining. If one starts a life with very little, and do not even get a good education, and then there will be very little protection from destitution.

This discrimination in the free market economies distorts earnings and can result in people from minority groups and disabled earning less for the same work as able bodied. The market system does not guarantee that everyone will have the same opportunity to accumulate wealth and hence an inequality. It is argued that the planned economy can lead to more equal distribution of income and wealthy since the production factors are controlled by the state. A command economy mighty not have the efficiency and enterprise for the successful of many people but at least the government will try to make sure that nobody falls through the safety net.

References List

  1. Beardshaw,J. et. al (1998) Economics a student`s guide,5th Edition, Prentice Hall. unabridged. Available at economy (accessed 3July 2013)
  2. Hall, R. and Lebierman,M.(2010)Microeconomic principle and application,5th Edition,Cengage learning
  3. Lipsey, R. and Harbury, C.(1992)Principals of economics,2nd Edition, Oxford: Oxford university press.
  4. Lipsey, R. and Chrystal, A.(1995)An introduction to positive economics ,8TH edition, London: Oxford university press. S
  5. tanlake, G. and Grant, S.(2000)Introductory economics, 7th Edition,London:Longman.

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Free Market vs Planned Economy. (2017, May 21). Retrieved from

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