In a Market economy the drive for optimum profit leads to the production of new products. Research and
Development (R&D) is a crucial factor in the free market in which firms and businesses must continuously
compete with others to be able to survive. This results in new technology and improves the use of resources and therefore productivity. Finally, the “price competition” between firms brings in new cheaper methods of production to create innovative products. However, the drawback of a free market economy is that owners only act in accordance with their own self interest and satisfaction; hence, some goods and services such as public goods are not or underprovided. Education is underprovided because it does not fulfil and satisfy the owners self interests. Thus, the accumulation of capital and wealth seems to be an unavoidable product of the (capitalist) market system.
A Centrally Planned Economy (Command Economy) is an economic system where the government controls and solves the basic economic problem of “what, how, and whom to produce”. Unlike a Market economy the state owns and allocates the factors of production (land, labour, capital, entrepreneurship) and makes all the decisions about the use of the resources and the distribution. “Market Socialism” is often used to describe a planned economy in which the “means of production” are owned by the state (public). Public Ownership suggests that in general, the profit of the economy is distributed fairly amongst the population to avoid wealth disparity. This system is maneuvered by 3 separate stages of assessing demand, assigning output and setting production targets where the markets have less influence in the output decisions as it is primarily planned and preformed by the “Central Planning committee”. Through this socialist based mechanism, prices
are usually set low in order for every citizen to afford the good, every citizen to have the right of employment and wages are set by the government rather than by separate firms.
Centrally Planned Economy’s were primarily a feature of “communist” countries mostly located i
Eastern Europe (Soviet Union). In this system, consumer demands are not necessary satisfied as the
government directs production of goods and services aimed to benefit the whole nation rather than a few
individuals. Essentially, central planning suggests that production units are given and assigned production
targets where “Economic growth” would be achieved through the progressing increase in the production targets.However, in generally production targets are not reached because of the lack of personal incentive and motivation to achieve beyond the target, opposed to a free market economy where the “competition” between firms and business drives the market. In addition, productions of goods and services are mostly inefficient and shortage of production is a common problem where in many cases factories are not provided with sufficient resources from the government to produce the goods and services.
Taken as whole a Planned Economy can continuously fully utilize its available resources to produce goods and services, hence, it does not suffer from the “business cycle”. Moreover, employment and production remain at effective levels which develop in a constant manner without the influence of supply, demand, or inflation as the resources are owned and allocated by the state. The system serves the benefit of the whole nation rather than individual ends by producing public and merit goods and services, which as a result aims to eliminate wealth disparity amongst the population as well as the creation of individual profit motives. However, the drawbacks of the planned economy are that government demands do not satisfy consumer demands and the lack of personal incentive and motivation to reach beyond the target production makes the economy a conservative market without innovative ideas and methods of production.
When a country makes a successful transition from a Centrally Planned Economy into a Free Market economy it goes through four fundamental processes of Liberalization, Stabilization, Privatization, and Legal reform which is also known as the “Big Bang approach” during China’s transition from a planned economy into a market economy in the late 20th century. Economic Liberalization allows prices of goods and services to be determined by the market force lowering trade barriers, Stabilization controls and lowers the sudden burst of high inflation; Privatization has ownership of resources to move form public to private and legal reform to outline the government’s position in the market and the establishment of free market policies. However, in many cases while a country makes a transition from a Planned Economy to a Market Economy the country goes through an economic downfall.
Initially, through the process of “deregulation” the ownership of firms and businesses will be moved from public to private ownership, thus it will allow individuals to solve the basic economic problem of “what, how, for whom to produce” in accordance with their self interest and satisfaction. As a result, the production of goods and services will be determined by the supply and demand of the good which will inevitably develop price and non-price competition between firms and businesses which will bring new cheaper methods of production to create innovative products and increase productivity of the available resources. However, as competition between firms develop, smaller firms and businesses will not be able to undergo such competition in opposition with large firms (monopoly), hence, small businesses will go out of business which will generate unemployment. In addition, the increase in unemployment will cause wealth and income disparity amongst the population which is a regular drawback in the Market Economy. During China and Russia’s transition from a planned economy to a market economy it was evident that a large portion (3.6%) of the work force was unemployed.
When transition economies undergo “Price Liberalization”, there is a move from fixed price mechanism to a free price system where the prices of the goods and services will be determined by the supply and demand for the good. Moreover, the personal incentive and motivation to achieve maximum profit will lead prices of
goods to rapidly increase opposed to a planned economy where the price of the good is controlled by the government. Thus, the rapid increase in price will cause inflation and form greater wealth disparity and
inequality where the majority of the population cannot afford to acquire the goods and services. Additionally, to control the inflation the government will increase the interest rates where it will make the consumption of goods and services expensive compared to before. As a result firms and businesses will acquire less profit where in some cases go out of business which will lead to an increase in unemployment. During Russia’s transition from a planned economy to a market economy inflation rates reached to a maximum of 2520 % which was a primary factor in the increase of unemployment.
In most cases, while a country undergoes an economic transition the GDP (Gross Domestic Product) will fall significantly as the aggregate output of the country decreases. An example would be when the Russian economy’s GDP dropped massively by 40% during its transition from a planned economy to a market economy. “Since during a planned economic system the level of output is “over estimated” by contradictory statistics without the consideration of “value added” in accordance with the market prices, hence, during the transition there will be a collapse in the output of the country” (1). Moreover, the sudden burst of uncontrolled high inflation of the goods and services decrease the demand for the good and eventually put a fall in the production. However, inflation rates are eventually controlled and stabilized in the following years.
Furthermore, through the process of “Legal reform” there will be less government interventions and as a result there will be a change in production from capital goods to consumer goods. This will only benefit the individual owners who aim to achieve maximum profit, rather than the incentive of economic growth. Additionally, there will be a decrease in subsidies provided by the government and a fall in tax collection as well as under supply of public and merit goods. Thus, the majority of the production of goods and services will be targeted to individuals who can afford them.
Through privatization, the country will then be open to trade which can shift the country’s production possibility frontier to the right, which will generate economic growth. During the planned economic system, trade was limited or not offered by the country while the move to a market economy suggests investment from country’s abroad. However, this was problem in Russia because of the inexperience of the people to specialize on a good and trade with other countries. Moreover, it was difficult for countries to trade effectively with other countries because of the worry of the stability of the country’s economy.
In Conclusion, as a country undergoes a transition in its economy there are many benefits and consequences which it must endure. However, the drawbacks occur during the transition of the economy, yet after the transition the country will be able to grow rapidly as China did after its transition from a planned economy to a free market economy.
Bibliography:
“Transition Economies” From planned to market systems Online
Available at September 19th
“Planned Economy” Wikipedia Online
Available at September 20th
“An IMF perspective on progress and prospects” International Monetary Fund Online
Available at (1) September 19th
