A:

Market economies and command economies occupy two polar extremes in the organization of economic activity. The primary differences lie in the division of labor or 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 determined by the supply and demand of goods and services. The United States, England, and Japan are all examples of market economies, as are most developed, democratic nations. Alternatively, a command economy is organized by government officials who also own and direct the factors of production. China, North Korea, and the former Soviet Union are all examples of command economies. 

Market Economy - The "Free Enterprise System"

The two fundamental aspects of market economies are:

1. Private ownership of the means of production

2. Voluntary exchanges / contracts

The most common title associated with a market economy is capitalism. Individuals and businesses own the resources and are free to exchange and contract with each other without decree from government 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 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.

Command Economy - Central Direction

Under a command economy, governments own all of the factors of production such as land, capital, and resources, and government officials determine when, where and how much is produced at any one time. This is also sometimes referred to as a "planned economy." The most famous contemporary example of a command economy was that of 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.

Major Criticisms of Each System

Karl Marx, a German philosopher, argued that a market economy was inherently unequal and unjust because power would be concentrated in the hands of the owners of capital. Marx is credited with coining 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.

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

RELATED FAQS
  1. What are some common features of a mixed economic system?

    Look at a brief overview of the defining features of mixed economies and its perceived advantages and disadvantages Read Answer >>
  2. How do command economies control surplus production and unemployment rates?

    Find out how and why command economies fail, why full employment is possible under state compulsion and why overproduction ... Read Answer >>
  3. How does capitalism work in a mixed economy?

    Read about how the forces of capitalism change in a mixed economy, and why governments intervene in voluntary exchanges to ... Read Answer >>
  4. Is the United States a Market Economy or a Mixed Economy?

    The United States is a mixed economy, it combines elements of a true free market economy with governmental, economic controls. Read Answer >>
  5. What role does the government play in capitalism?

    Take a deeper look at the role of government in a capitalist economic system and about competing ideas about the proper amount ... Read Answer >>
  6. What is the history of the market economy?

    Take a quick tour through the history of the market economy -- the system of voluntary economic exchanges guided by private ... Read Answer >>
Related Articles
  1. Investing

    What's a Centrally Planned Economy?

    A centrally planned economy is one where the government controls the country’s supply and demand of goods and services.
  2. Investing

    Which Countries Will Drive Global Growth in 2016?

    Given the volatility that has already shaken the global economy, the world's largest economies will be leaned on to stimulate growth in 2016
  3. Insights

    The History Of Economic Thought

    Economics is a vital part of every day life. Discover the major players who shaped its development.
  4. Investing

    Will China Suffer a Fate Similar to That of the Soviet Union?

    Many parallels could be drawn between the former USSR and today's China, but the one similarity the CCP wants to avoid is the Soviet Union's collapse.
  5. Insights

    Why Can't Economists Agree?

    There are many reasons why economists can be given the same data and come up with entirely different conclusions.
  6. Insights

    What Exactly is a Socialist Economy?

    Socialism's role in the world has changed dramatically in the last several decades.
  7. Investing

    Impact of the Chinese Economy on the U.S. Economy

    The economic growth of China has been decreasing since 2010. What impact does this have on the US and the world economy?
  8. Insights

    Four Factors Supporting the Global Economy in 2016

    The global economy enters 2016 on a promising note, with the growth pace forecast to be the fastest since 2011, thanks to a combination of four potent factors.
RELATED TERMS
  1. Centrally Planned Economy

    An economic system in which economic decisions are made by the ...
  2. New Economy

    New economy is a buzzword describing new, high-growth industries ...
  3. Old Economy

    Old economy is a term used to describe companies that enjoyed ...
  4. Market Economy

    An economic system in which economic decisions and the pricing ...
  5. Socialism

    An economic and political system based on public or collective ...
  6. Sluggish Economy

    A state in the economy in which the growth is slow, flat or declining. ...
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  3. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. ...
  5. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability of potential investments.
  6. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
Trading Center