This pages will explain the different types of market system and identify the key features of each system.
Free Market Economy
- All resources are owned & controlled by private individuals
- There is NO Government & Taxes
- Consumers decide on what should be produced by what they buy
- Resources are distributed through the price mechanism
- All firms aim to maximise their profits
- There are no examples of free market economies in the World
Advantages
- Consumers are free to choose what they want to buy.
- Workers are encouraged to work hard as they can keep most or all of their incomes because of low or non-existent taxes.
- Businesses compete with each other and this could keep prices low.
- New businesses are encouraged to set up in order to make profits – profit maximisation
Disadvantages
- No services, such as health and education services, available to everybody, only bought by those who can afford it!
- No government planning = many uncontrolled booms or recessions in the economy.
- Businesses might be encouraged to create MONOPOLIES in order to increase prices. Consumers would have limited choice.
- Everyone operates with their own self interest
Planned Economy
- Everything is decided by the Government
- Resources are owned by the State
- The Government controls all businesses
- Very few examples in the World today
Advantages
- Government decides what should be produced, how much and for whom
- Decreases inequalities
Mixed Economy
- A mixture of free enterprise and state controlled
- Some resources owned by the State and some by private individuals
- Businesses make decisions & the Government try to influence and control some areas such as Taxes & Laws.
Advantages
- Government control should eliminate any waste resulting from competition between firms.
- There should be work for everybody.
- The needs of the population are met, but there is little production of luxury goods for the wealthy.
Disadvantages
- There is less incentive to work as the government fixes wages and private property is not allowed.
- The government may not produce goods which people want to buy.
- The lack of a profit motive for firms leads to low efficiency.
The Effectiveness of the Market System
The allocation of resources in the market system is not always efficient
Governments may use taxes and subsidies to try and correct market failure
The market system only allocates resources to those who are able to pay
Interrelationships between Markets
Changes in one market are likely to influence other markets
Composite demand is the demand for a product that has more than one use
Derived demand is where demand for one good or service is due to demand of another. This may be due to the production process. E.g. demand for trainers will increase demand for rubber
Joint demand is where the demand of one product is tied to the demand of another. Joint demand occurs when products are complements in production or consumption. Because the products are used together the demand for one good is tied to the demand for the other good. E.g. tea and milk – if there is no milk demand for tea would decline
How Markets and Prices Allocate Resources
Markets allocate resources as they allow all consumers who are willing and able to purchase goods at a set price to receive them
Prices allow a good to be rationed – if the product is in short supply the price of the good will increase so only those willing to pay the highest prices will be allocated the resources
Incentives are any factor (financial or non-financial) that provide a motive for a course of action
Incentive pricing aims to encourage consumers to purchase a particular product increasing its demand
Prices can also be used as a signaling tool
Often high prices are seen to reflect high quality
