During the great depression of the 1930s with mass unemployment, J M Keynes came up with his idea of government intervention in the economy by using fiscal policies. He called for governments to create jobs and raise the levels of consumption. He called for a simulation of the economy by the government playing a big role in order to aggregate demand. Keynes’s ideas led to state-owned enterprises. This is the beginning of nationalization and this I was the time when the true nature of command economies was revealed Even though USSR became communist in 1917, there still had not been a proper understanding of what ‘command economies’ were until Keynes’s ideas were put forward. Immediately, there followed a massive move towards nationalization. In the late 1940s, British Railways, BBC, British Steel and British gas were nationalized. Of course, Britain was a mixed economy, it still contained what we now call a ‘private sector’.
Advantages of Market Economies
- Prices serve as signals to both producers and buyers so that producers will know which items are selling well and where to invest in while buyers are easily able to determine how to budget their incomes for the goods. This is because producers aim at profit maximization and consumers aim at utility maximization.
Buyers will buy more when the prices fall; Producers will supply more when prices go up. This is indicated in Fig 1.2
As is seen, as price increases, quantity demanded reduces. This goes to show that, due to high competition and the motivation for profits, producers tend to make their prices as low as possible – this leads into a lot of demand. Free-market economies often experience high demand. The implication of high demand are:
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High employment - Producers sell more goods, make more money and employ more people to produce more and more goods.
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Higher profits – Higher demand results into higher money inflow and higher long-term profits.
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Economic Growth – When there is more demanded, more has to be spent, hence more has to be borrowed (from outside the country) – this encourages money pump-in. When this happens, the country heads towards a trade surplus and eventually into a budget surplus. This caused economic growth.
- Higher Standard of Living
- More FDI, Foreign Direct Investment.
- The free market system helps to allocate resources uniformly so that there is a shift from less efficient use to more efficient use. This is caused by competition – and this ‘competition’ is only found in market economies.
e.g. When a farm owner, who is currently renting out his plot to a maize farmer for $200 is approached by a rice farmer wanting the same plot for a rent of $600, the far owner will be forced to give his farm to the rice grower. When the maize grower is made to leave and eventually goes to a new plot, he makes better use of his resources in order to avoid losing this plot too – he will think about growing both maize and rice, automate his farm, reduce his expenditure and try to cut down on fixed costs. This results into an overall increase in efficiency. This same farmer might later go to the old far owner and tell him that he would be willing to pay $1200 for the plot. This benefits three people a. the farm owner who tends to be getting more and more money b. the maize farmer who seems strive for efficiency c. the rice farmer, who, has to be innovative in order to retain his dominance.
- Variety of choice: there are many producers offering different varieties of goods. Hence, consumers can chose according to their taste, fashion, family size, income etc.
- Free market system beings about innovation and new ideas. Higher number of opportunities for innovation, creativity and generation of brilliance are available in market economies.
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Free market economies encourage hard work – everyone has to work to make money. The over-reliance on government aid is not seen.
- There will be no restriction. There are usually no embargos, no tariffs, no foreign investment restriction and most of all, no hostility towards foreign investment.
e.g. Hong Kong, a country which solely exports 42% of Chinas out-bound production is the outlet for all Chinese goods – why? It is a free market economy – there are no restrictions, no embargos, no tariffs and there is no harassment. It is the 10th largest trading entity, 7th largest single trading body, it has the 9th largest banking corporation and on top of all these, it is the most free market economy in the world. The encourages not only trade, but also investment. Foreign investors are attracted.
Disadvantages of Free-market Economies
1. Some merit goods, such as education and health, may not be sufficiently provided – this is a punishment to the poor.
2. Excess competition can collapse the weaker firms and can cause unemployment to the employed people.
3. Social costs such as pollution, noise, congestion will be high and difficult to control. This will, in a way, lead to lower standards of living, poor health condition and may eventually result into a higher death rate.
- Wide income gaps will exist between the poor and the rich – the poor will get richer and the poor poorer. This is one of the bad implications of the kind of tax structure found in free market economies.
- Harmful goods such as illegal drugs, ammunition etc. will be produced because of the cut-throat competition and the strong urge for money that these economies create. This excess desire for money, could indeed, lead to violence, higher crime rate and more deaths.
- Social support is unseen – government benefits are low. People are on their own. While in command economies, governments are there to support the person, whenever and wherever.
- Public goods like roads, traffic lights etc are nonexcludable. Some, who evade tax, still enjoy the benefits. In command economies, however, this is not the case because everyone has to work and feed the nation. The dependency ratio, in free market economies, is therefore very high.
