Types of Economy

1
Types of Economy

• Free Market Enterprise ( pure capitalism)
• Decisions are made by the individual buyers and
  sellers who act in their own self-interest
  producers aim to maximize profits, consumers aim
  to maximize utility (marginal benefit,
  satisfaction)
• Price mechanism allocates resources

2
Types of Economy

• Centrally Planned Economy/Command Economy
• 1. Decisions made by central planning agency
• 2.Government/state owns resources
• 3. Prices set by the state
• 4.motive for production is social welfare
• 5. Lack of market forces

3
Advantages of the free market

• Resources are allocated efficiently by the price
  mechanism (Called the Invisible hand by Adam
  Smith)
• The profit motive provides an incentive to reduce
  costs and innovate and be efficient
• The free market utilizes community surplus if
  there are no market imperfections

4
Advantages of the CPE

• Government can influence the distribution of
  income.
• Government can determine what goods are supplied
  (it can prevent the production of socially
  undesirable goods)

5
Disadvantages of CPEs

• 1.Requires an enormous amount of information
  information overload leading to inefficiency
  (often bureaucratic.)
• 2.No positive incentive for individuals of firms
  to be innovative goods are of poor quality and
  limited choice.
• 3.Liable to lead to allocate and productive
  inefficiency due to that lack of competition and
  no profit motive.

6
Problems when government intervenes in the market
place

• Lack of information on the extent of the problem
• Difficulty quantifying the extent of the problem
  (value placed on damage by pollution)
• Mistiming
• Administrative costs
• Political pressure, to equalize society more than
  is societally optimal

7
Government intervention

• Can directly provide goods (public goods)
• Legislate (e.g merit goods such as education,
  demerit goods such as drugs
• Provide incentives and disincentives through
  taxation and subsidies
• Public Choice Theory assumes that governments
  try to maximize their self interest (I.e get
  re-elected) this can lead to inappropriate short
  term involvement at the expense of the long term.
• Danger of regulatory capture (undue influence)

8
Disadvantages of the Free Market

• 1.Public goods are not provided
• 2.Merit goods are underprovided
• 3. Demerit goods are overprovided
• 4.Instability
• 5.Inequality
• 6.Negative externalities are overproduced
• 7. Positive externalities are under produced
• 8. Informational problems
• 9. Market power
• 10. Factor immobility