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Market economy versus command economy: an overview

Market economies and command economies occupy two polar extremes in the organization of economic activity. The main differences lie in the division of labor, or the factors of production, and the mechanisms that determine prices. Activity in a market economy is unplanned; it is not organized by any central authority but is determined by supply and demand for goods and services. The United States, England and Japan are all examples of market economies.

Alternatively, a command economy is organized by a centralized government that owns most, if not all, of the businesses and whose officials run all the factors of production. China, North Korea and the former Soviet Union are all examples of command economies. In reality, all economies mix a combination of market and command economies.

Key points to remember

  • Market economies use private property as a means of production and voluntary exchanges/contracts.
  • In a command economy, governments own the factors of production such as land, capital and resources.
  • Most nations operate largely as a command or market economy, but all include aspects of each other.
  • The type of economy also influences the political and social landscape of a nation, with command economies being more authoritarian and market economies allowing for more personal freedoms.

Market economy

The two fundamental aspects of market economies are private ownership of the means of production and voluntary exchanges/contracts.

The title most commonly associated with a market economy is capitalism. Individuals and companies own the resources and are free to trade and contract with each other without decree from governmental authority. The collective term for these uncoordinated exchanges is the “market”.

Prices arise naturally in a market economy based on supply and demand.

Consumer preferences and resource scarcity determine what goods are produced and in what quantities; prices in a market economy act as signals for producers and consumers who use these price signals to help make decisions. Governments play a minor role in guiding economic activity.

Businesses in a market economy are expected to regulate their behavior, while consumers are expected to look after their own interests and protect themselves against fraud and abuse. Market economies are not concerned with ensuring that those less fortunate have access to essential goods and services or opportunities.

Karl Marx, a German philosopher, argued that a market economy was inherently unequal and unfair because power would be concentrated in the hands of the owners of capital. Marx popularized the term capitalism.

John Maynard Keynes, an English economist, believed that pure market economies were unable to respond effectively to major recessions and instead argued for major government intervention to regulate business cycles.

Command Economy

In a command economy, governments own the factors of production such as land, capital, and resources, and government officials determine when, where, and how much is produced. We also sometimes speak of a planned economy. The most famous contemporary example of a command economy is that of the former Soviet Union, which operated under a communist regime.

Since decision-making is centralized in a command economy, the government controls all supply and sets all demand. Prices cannot arise naturally like in a market economy, so prices in the economy must be set by government officials.

In a command economy, macroeconomic and political considerations determine the allocation of resources, whereas in a market economy, the profits and losses of individuals and businesses determine the allocation of resources. Command economies aim to provide basic necessities and opportunities to all members.

Ludwig von Mises, an Austrian economist, argued that command economies were untenable and doomed to failure because no rational price could emerge without competing private ownership of the means of production. This would lead to massive shortages and surpluses.

Milton Friedman, an American economist, noted that command economies must limit individual freedom to operate. He also believed that economic decisions in a command economy would be made based on the self-interest of government officials and would not promote economic growth.

Special Considerations

Most market and command economies today operate with elements of both. For example, Cuba has traditionally been a command economy but has made significant economic reforms to improve the condition of the nation. Many enterprises have been privatized and no longer operate under government authority, which is a feature of a market economy.

Conversely, the United States, which is a market economy, switched to a planned economy to mobilize during World War II. The United States also has elements of the command economy, as in the medical services provided to the elderly.

Traditionally, the type of economy has also determined the political and social landscape of a nation. Command economies have been associated with authoritarian regimes that limit individual freedoms, as stated by Milton Friedman. Market economies tend to be democracies that allow almost total personal freedom.