Chapter-5

Free market economy:

The free market is an economic system based on supply and demand with little or no
government control.
It is a summary description of all voluntary exchanges that take place in a given
economic environment. Free markets are characterized by a spontaneous and
decentralized order of arrangements through which individuals make economic
decisions.
Examples:
Singapore's economy is considered the freest, followed by Switzerland and Ireland,
according to the Heritage Foundation's 2022 Index of Economic Freedom.
Luxembourg, Taiwan, Estonia, the Netherlands, Finland, and Denmark round out the
2022 top ten. The United States ranks just 25th on the list.

Command or planned economy:

A command or planned economy occurs when the government controls all major
aspects of the economy and economic production.
In a command economy, it is the government that decides what to produce, how to
produce goods and how to distribute goods and services within the economy.
Examples:
A communist nation like the former Soviet Union, Cuba, and North Korea work
according to this system.

Mixed economy:
A mixed economy means that part of the economy is left to the free market, and part of
it is managed by the government.
Mixed economies start from the basis of allowing private enterprise to run most
businesses.
Then the governments intervene in certain areas of the economy, such as providing
public services (health, education, waste management) and the regulation or private
business (e.g. legal right to private property, and abuse of monopoly power)
In reality, most economies are mixed, with varying degrees of state intervention. Mixed
economies typically maintain private ownership of most of the means of production, with
the government intervening through regulations.

Page 1 of 5
Examples of mixed economies:
Share of government spending as a % of GDP
Iceland (57%)
Sweden (52%)
France (52.8%)
United Kingdom (47.3%)
United States (38.9%)
Russia (34.1%)
India – (27%)
China – (20%)
Hong Kong (18.6%)
Advantages of command economies:
 Supporters of command economies argue that it enables the government to
overcome market failure, inequality and create a society that maximises social
welfare rather than maximises profit.
 Command economies can prevent abuse of monopoly power.
 Command economies can prevent mass unemployment, often a feature of
capitalist economies.
 Command economies could produce goods which benefit society and ensure
everyone has access to basic necessities.
Disadvantages of command economies:
 Government agencies usually have poor information about what to produce.
Centralisation means that decisions are taken by people who may have no
access to what is actually happening. Command economies, like the Soviet
Union, often produced goods that weren’t used.
 Unable to respond to consumer preferences.
 Inefficient firms are protected and kept going; making it hard for resources to
move to dynamic and efficient firms.
 Threat to democracy and liberty. A command economy creates a very powerful
government which limits individuals rights to pursue economic objectives. This
invariably creates a climate where governments can extend their control into
other areas of people’s lives.

Page 2 of 5
Advantages of free market economy:
The advantages of a market economy include increased efficiency, productivity, and
innovation.
Business Efficiency:
Unlike other types of economies, a market economy increases business efficiency and
competition. Governments, in their limited roles, work to promote this by creating and
enforcing legislation that places limits on activities that detract from a competitive
environment. They also support business efficiency but regulate how businesses treat
consumers and workers to maximize efficiency.
Efficiency is usually measured in terms of costs and profits. High efficiency is typically
viewed as low costs and high profits, whereas low efficiency is viewed as high cost and
low profits. Competition plays a role in efficiency because it forces businesses to do
whatever is necessary to lower costs, control more of the market, and achieve higher
sales to increase profits, as long as it is legal.
Increased Productivity:
Increased productivity is also associated with a market economy. In any economy,
people need money to purchase goods and services. In a market economy, this need
leads to increased motivation because workers want to earn more money to supply their
needs and to live comfortably.
People motivated to work increase productivity and output for the economy. In a
command economy, where a central authority or government sets wages, levels of
production, prices, and investments, there is less worker motivation because no matter
how much harder they work, they will not see additional monetary benefit.
Innovation for a Competitive Edge:
A country's market economy supports increased innovation. Firms and individuals are
encouraged to innovate to gain a competitive advantage and increase their market
share. With money as a primary motivating factor, companies look to create new
products and technologies to generate more revenue, higher incomes, and more profit.
Innovation also leads to a greater variety of goods and services, which provides a
broader selection for consumers.
Disadvantages of free market economy:
 Inequality: The wealthy will tend to be able to accumulate greater wealth in a free
market. This is due to the ability to inherit wealth. Wealthy can pay for better
education for their children, giving certain groups of people a better start in life.
People with wealth and assets can use profit and dividend to purchase more

Page 3 of 5
 assets. The rich can accumulate more. The wealthy are likely to be able to create
monopoly power, which exacerbates inequality.
 Monopoly power. In a free market, firms with a high market share will be able to
set higher prices for consumers.
 Instability of free markets. John Maynard Keynes argued capitalism has a
tendency to boom and bust economic cycles – which leads to periods of mass
unemployment. Hyman Minksy suggested that financial markets were inherently
unstable due to forces of irrational exuberance. See: Financial instability.
 Unsustainability. Free markets are concerned with the present moment but
ignore implications for long-term ecological stability. For example, free markets
may lead to the over-use of raw materials and

The role of the state in mixed economy:

A mixed economy typically combines the features of a market-based economy with a
strong public sector. While most prices are set by supply and demand, the government
may intervene in the economy by enforcing price floors or ceilings for certain goods, or
by directing public funds to certain industries at the expense of others.
The following are common examples of mixed-economy policies:
Social Welfare Programs
Most mixed economies, even heavily market-oriented ones, offer benefits to those living
at or near the poverty level. In the United States, the federal government
provides SNAP benefits, Medicaid, and public housing to low-income individuals, while
many state governments provide their own benefits.
Many countries in Western Europe have extremely generous social welfare programs,
as well as government-provided health care and strong labor protections.
Price Controls / Subsidies
While prices in a mixed economy are generally set by the market, the government may
intervene to prevent the prices of certain commodities from rising or falling below a
certain level. For example, most mixed economies have minimum wage laws to prevent
exploitation of the workforce, and they may use subsidies to support farmers or other
key industries.
Strong Business Regulations
While most business activity is guided by the free market, governments may use
regulations to protect the public from dangerous products, pollution,
or monopolistic business practices. Many mixed economies have anti-trust laws to
ensure that the marketplace remains competitive.

Page 4 of 5
Page 5 of 5