ALLAMA IQBAL OPEN UNIVERSITY COMMON WEALTH MPA PROGRAM AD 593699 Question No 1 (B) How different is a market economy from

a centrally planned economy? Ans : A centrally planned economy is an economy where the State decides solely on what to produce. A Market Economy revolves around competition by firms and firms base their products on what consumers are demanding. Generally speaking, Market Economies are a lot better. Centrally Planned Economies make products which are 'worthless': E.g. If the State produces a car and you do not like it, its either you have it or don't have it. In Market Planned Economies, the consumer has the choice of choosing a wide range of car brands, i.e. BMW, Ford, Audi etc.

Central Planning: A centrally planned economy relies on a party in power to decide what resources should be allocated to various demands as they see fit. Free Market: A free market economy relies on prices to determine where demand should be filled and to what extent. A market economy is generating through buying and selling, prices determined by demand and a planned economy is where a government determines pricing for goods and services.

y y

In a planned economy government makes all decisions about the use of a country's resources. The opposite, a free market economy, has theoretically zero government involvment, and production and allocation decisions are made through interactions between buyers and sellers. A mixed economy is a hybrid of the two. market economy is where the supply market is freely engaged to meet the demand, these condition also apply to money market and domestic currencies, thus resulted price fluctuation. Whereas planned economy is more likely to be controlled by government, these include controlled supply, demand, money market and domestic currency value. In a market economy, the prices of goods and services vary according to supply and demand. In a planned economy, a central body controls supply and prices. Command Economy A market where the government or some central authority decides where to allocate resources

o Initially higher growth rates for Russia and China would suggest that as a system of organizing economic activity. to determine what is produced. requires an enormous amount of information which is difficult to obtain. A reluctance to change with the market in forecasting demand: There are queues when there are shortages (quantity rationing). firms are simply told to produce a certain number of goods or services 1. o There is no incentive for individuals and firms to be innovative. No real incentive for individuals to be innovative. Govt. The government can determine which goods are supplied.6 Central planning: y y y y y y y y y Resources and production systems are owned by the central government which allows the govt.Advantages and Disadvantages of a Planned Economy Advantages: y y The government can influence the distribution of income. The economy does not respond as well to supply and demand.the government has the ability to abuse its absolute power. Goods are of poor quality since there is a lack of profit motive. With no profit motive goods are often of poor quality and choice is very limited. and stockpiles if there are surpluses. May NOT lead to allocative efficiency or productive efficiency due to lack of competition and profit motives. how and for whom. . central planning is successful in the early stages of economic development Disadvantages of central planning: o Requires large amounts of information: forecasting people¶s desires is difficult and the lack of incentives have led to a number of problems: Decision makers do not experience profits and losses and are not strongly motivated to make the right decisions Incentives to falsify production information lead to poor production decisions and massive pollution. Corruption . planners must: o Predict patterns of consumer demand o Estimate technological possibilities and production capabilities Producers are motivated to underestimate their capability Advantages of central planning: o The govt. o State owned enterprises are managed inefficiently. Disadvantages: y y y y y In order to function well. can make the distribution of income more equal o The govt. determines what goods are produced and can prevent production of socially undesirable goods. Enormous information is required due to centralized planning and control.

and forces producers to reduce costs and be innovative. Advantages of free market: o Resources are allocated by market forces and the price mechanism without govt. but if they are poor at predicting: o They produce too much (surpluses) and will lose money. o The free market maximizes community surplus if there are no failures and imperfections. market system relies on a number of factors to ensure that it works efficiently. Union Carbide's gas leak in Bhopal is an example of such an externalized cost. The profit motive is a great incentive. With no imperfections. intervention. If the market structure does not include limiting social forces. will miss the potential profit and a competitor will make the profit instead. Producers attempt to maximize profits. Free market y y y y Resources and production systems are owned by individuals and the allocation of resources. eliminating the associated costs and thus maximizing profit. . financial forces will cause firms to externalize costs such as pollution to gain monopoly. o Profits provide an incentive to reduce costs and be innovative.Free Market The forces of supply and demand decide the economic questions and therefore where to allocate resources Advantages and Disadvantages of the Free Market Advantages y y y y y y y y Resources allocated more efficiently by the price mechanism. the free market maximizes community surplus. Only those firms which can predict most closely what consumers will want will earn adequate money to stay in business.the incentive for a reward for enterprise ‡Good levels of information being available to both producers and consumers ‡Price accurately reflecting the costs and benefits of consumption and production ‡The ease with which resources can move to different uses At the heart of the market system is the profit motive. as this eliminates competition. ‡The profit motive . how and for whom.The natural goal of all firms is to attain monopoly. o They underestimate (shortages). is left to the forces of supply (production) and demand (consumers) operating in a relatively free market. what. Entrepreneurs Disadvantages: y y y Instability Market FailureMonopolies and corruption .

Both public and private sector are working mutually for the allocation of resources. o The system of profits and losses is thought to be unfair. .y y y Disadvantages of the free market: o Market failures and imperfections occur because of public goods. substantial govt. In the current scenario almost all the countries of the world are working with the Mixed Economic system. intervention is needed to cope with income redistribution problems. are supported with tax money o The system is incapable of controlling pollution and producing sustainable growth. merit goods. externalities and lack of competitive markets. The wealthy are taxed to reduce profits Those marginalized by the system. planning has been introduced to correct for this problem.

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