Market Economy vs. Command Economy: An Overview
Market economies and command economies are the two polar extremes in the organization of economic activity. The primary differences surround who controls the factors of production and the mechanisms that determine prices.
The activity in a market economy is unplanned. It is not organized by any central authority but is instead determined by the supply and demand of 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, businesses and where government officials direct all the factors of production. East Germany, North Korea, and the former Soviet Union are all examples of command economies. In reality, all economies blend some combination of market and command economic principles.
- Market economies utilize private ownership as the means of production and voluntary exchanges/contracts.
- In a command economy, governments own the factors of production and set prices and production schedules.
- In a market economy, prices are set by supply and demand.
- Most nations operate largely as a command or market economy but all include aspects of the other.
- Since a command economy requires a large administrative state, a country's economic system is closely related to its political system.
The two fundamental aspects of market economies are private ownership of the means of production and voluntary exchanges between economic actors.
Market economies are closely associated with capitalism. Individuals and businesses own the resources and are free to exchange and contract with each other without permission from government authorities. The collective term for these uncoordinated exchanges is the "market."
The first economist to examine market activity was Adam Smith, who compared it to an "invisible hand" distributing resources to the public.
Consumer preferences and resource scarcity determine which goods are produced and in what quantity. The prices in a market economy act as signals to producers and consumers who use these price signals to help make decisions. Governments play a minor role in the direction of economic activity through taxes and regulation.
There is little supervision over businesses in a market economy, and consumers are expected to look out for their own best interests and protect themselves from fraud and abuse. Market economies are not concerned with ensuring that less fortunate people have access to essential goods and services or opportunities.
Karl Marx, a German economist, argued that a market economy was inherently unequal and unjust because wealth and power would concentrate 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 effectively respond to major recessions and instead advocated for major government intervention to regulate business cycles.
After the political revolutions of 1989, many former command economies embraced the free market.
Under a command economy, governments own the factors of production such as land, capital, and resources, and officials determine when, where, and how much is produced. This is also sometimes referred to as a planned economy. The most famous example of a command economy was the former Soviet Union, which operated under a communist system.
Since decision-making is centralized in a command economy, the government controls all of the supply and sets all of the 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 resource allocation, whereas, in a market economy, the profits and losses of individuals and firms determine resource allocation. Command economies are concerned with providing basic necessities and opportunities to all members.
Ludwig von Mises, an Austrian economist, argued that command economies were untenable and doomed to fail because no rational prices 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 political self-interest of government officials and not promote economic growth.
Most market economies and command economies today function with elements of both. For example, Cuba has long been a command economy but has made significant market reforms to improve the condition of the nation. Many businesses have been privatized and no longer operate under the authority of the government, which is a characteristic 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 U.S. also has other elements of a command economy, such as subsidies and welfare programs.
The type of economy may also influence a country's political landscape. Milton Friedman has argued that command economies were likely to become authoritarian regimes because economic freedom is closely tied to political freedom. However, the relationship is not absolute: There are many democracies with a strong welfare state and many dictatorships with free-market economic policies.
What Are the Advantages of a Market Economy?
In a market economy, prices are set by the decisions of thousands of consumers and producers, each acting in their own self-interest. The profit motive and competition between businesses provide an incentive for producers to deliver the most desirable, cost-effective products at the best possible price.
What Are the Advantages of a Command Economy?
A command economy allows a nation to direct resources towards priorities that would not be adequately served by free-market forces. Many market-oriented countries adopt central planning measures during times of war or crisis, in order to prevent shortages. For example, during the COVID-19 emergency, the United States invoked the Defense Production Act to order the production of vaccines and testing supplies.
What Is a Mixed Economy?
A mixed economy combines the elements of both socialism and capitalism, with the government regularly intervening in the market to prevent shortages and address economic problems. China, Singapore, the United Kingdom, and many European countries are classic examples of mixed economies, in that they have a large public sector and a welfare state. In reality, almost every country can be considered a mixed economy to some extent.