Discuss the advantages and disadvantages of a free-market economy:
- Price Mechanism:
Through free market concepts such as price signal and opportunity cost, the free market supplies a method of pricing resources without government intervention. An example being if there is great demand for a resource and it is scarce price rises, and vice-versa.
- Self-Adjustment (equilibrium):
Resources are basically allocated by the supply and demand relationship, if there is a demand for a resource then someone will look to make profit and provide a supply. However the market ultimately decides the price, and self-adjusts so unless there is a sudden change in supply or demand theoretically there will be no shortage or surplus.
- Human Psychological Aspect:
Each person effectively looks after themselves; there is that necessity of personal gain to feel progress is being made to achieving happiness.
We have been brought up to believe that the way to gain is to obtain employment, therefore earning money, allowing us to express effective demand over wants and needs.
The free market allows the creation of competition which suits the consumer; people like to have options this therefore creates space for producers to create better products cheaply aiming to achieve a greater hold over the market.
- Speculation & Bubble:
The free market can allows certain resources to be over-valued on false pretences, factors such as insider information or industrial espionage can lead to price surge or crash. A superficial bubble can be produced, as a certain resource should crash but people are continually trying to keep it up.
- Undervaluation of Needs:
Since there is a concentration on immediate gain and short term perspective through the free market, important services such as education and health tend to be undervalued by consumers. In a utopian free-market these services would be accurately priced, but this does not occur in reality.
- Monopoly & Duopoly:
If a producer gains to great of a market share they begin to control prices themselves, which leads to the failing of the pricing mechanism and the supply/demand relationship. This is against the interest of the consumer, and misallocates resources. An example of a prominent duopoly situation is Airbus vs. Boeing.
Discuss the advantages and disadvantages of a command economy:
- Planned & Greater Predictability:
In a command economy the government sets production and growth targets, there is an idea of the bigger picture on how the economy will perform in the future. This theoretically increases the economic stability, such as maintaining the value of a currency or given resource (less volatile, fluctuation a rare occurrence)
- Elimination of Opportunity Cost:
Since the government allocates the resource the consumer does not question the practicality or use of a given resource, this usually takes the form of coupons. The consumer does not lose out the ability to consume another resource when a coupon is used as it only works for a certain resource.
- Valuation of Services (education, health, etc.):
There is the organisation of a social health and education system, ensuring that everyone can attend school and receive an education as well as ensuring that people are medically taken care of. This stops people from thinking in the short term, and the government is allowed to independently decide the value of education (i.e. the creation of an education budget).
- Reduction of Inequality:
The government decides on how the country’s wealth is distributed, in theory this stops anyone from having more money than they “need”. This allows people with service jobs to still have food, healthcare, and education. This achieves social justice as those with jobs such as janitors are valued workers.
- Misallocation of Certain Resources:
The government will not always know how much to give or produce of a certain resource. For the government to effectively allocate resources in this situation it must have large amounts of information on the populace of the country. This also raises the question does a doctor deserve more or equal to someone of a lesser profession such as a cleaner.
- Lacking Innovation (no choice or variety):
There is only ever the production of one type of product, as it becomes a national brand as if there could only be Marlboro Cigarettes and Colgate toothpaste. This means there is no competition which leads to a lack of innovation.
- Shortages & Surplus
When the government misallocates resources, it may decide to change production of the resource. The problem with this aspect may lead to too little of the resource being produced or too much, this is because it is difficult to understand consumer demand.
- The free-market handles itself, whereas the command economy requires people to regulate all aspects and control it. This means that the producers lack profit motive and see no reason to “work harder” but to simply meet the quota.
What is the optimal level of government intervention and what does it depend on?
When looking at the role of the government in economics it is important to separate regulation and intervention. As such government regulation is a necessity, it allows us to have control to ensure that the economy serves everyone best interest.
Regulation can take form in any manner, but is in the interest of the government to provide regulation that does not hinder innovation or competition. However, it is equally important that regulation ensures that monopolies do not occur, as it does not serve the general public interest. Regulation is also important when factors such as the environment are involved, as it is in the general public’s interest to live in a healthy environment. Therefore, regulations on pollution levels are put in place and fees are introduced such as carbon tax to impose the regulation.
The government should rarely truly intervene in the economy, granted for situations such as economic collapse or hyperinflation the government must act. The situation needs to be truly dire for the government to intervene but what is more important is how the government intervenes. Allowing some aspects to fail is of great importance as it shows what must be changed; this is opposite to what governments did during the 2007-2008 financial crises where the British government decided to buy into the failing banks essentially de-privatising them.
The inclusion of government and the role of central banks is a controversial and debatable topic. There is no right or wrong as such, and every country needs a different mixture between government control and regulation and the allowance of a free market.