Last Updated 17 Aug 2022

The Three Methods of Resource Allocation

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•In a traditional economy, resources are allocated according to the long-lived practices of the past. Tradition was the dominant method of resource allocation for most of human history and remains strong in many tribal societies and small villages in parts of Africa, South America, Asia, and the Pacific. Typically, traditional methods of production are handed down by the village elders, and traditional principles of fairness govern the distribution of goods and services. Economies in which resources are allocated largely by tradition tend to be stable and predictable. But they have one serious drawback: hey don’t grow. With everyone locked into the traditional patterns of production, there is little room for innovation and technological change. Traditional economies are therefore likely to be stagnant economies.

•In a command economy, resources are allocated by explicit instructions from some higher authority. Which goods and services should we produce? The ones we’re ordered to produce. How should we produce them? The way we’re told to produce them. Who will get the goods and services? Whoever the authority tells us should get them. In a command economy, a government body plans how resources will be allocated. That is why command economies are also called centrally planned economies. But command economies are disappearing fast. Until a few years ago, examples would have included the former Soviet Union, Poland, Rumania, Bulgaria, Albania, and many others. Beginning in the late 1980s, all of these nations have abandoned central planning. The only examples left are Cuba, China, and North Korea, and even these economies—though still dominated by central planning— are moving away from it.

•The third method of allocating resources—and the one with which you are no doubt most familiar—is “the market.” In a market economy, neither long-held traditions nor commands from above guide our economic behavior. Instead, people are largely free to do what they want with the resources at their disposal. In the end, resources are allocated as a result of individual decision making. Which goods and services are produced? Whichever ones producers choose to produce. How are they produced? However producers choose to produce them. Who gets these goods and services? Anyone who chooses to buy them. There are, of course, limitations on freedom of choice in a market economy. Some restrictions are imposed by government to ensure an orderly, just, and productive society. We cannot kill, steal, or break contracts—even if that is our desire— without suffering serious consequences. And we must pay taxes to fund government services. But the most important limitations we face in a market economy arise from the overall scarcity of resources

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