Resource allocation in different economic systems

Although we have mainly considered resource allocation through the market mecha-
nism, there are in fact different types of economic system for allocating resources.
Three particular types of economic system are often discussed in the literature.

■ Pure market economy

■ Pure command economy
■ Mixed economy

We briefly review the characteristics of each type below, together with their advantages
and disadvantages.

Watch out! Of course, in reality most economies might more accurately be located somewhere along a
spectrum running from the pure market economy at one extreme to the pure command
economy at the other extreme.

■ Pure market economy

■ Markets alone are used to allocate scarce resources of land, labour and capital.
■ Prices (determined on markets) act as ‘signals’ to producers and consumers, bringing
supply and demand into balance (equilibrium).

■ No direct role for governments in resource allocation – their main task is to provide
the infrastructure needed to allow markets to work (e.g. law and order, defence
etc.).
■ Advantages – markets co-ordinate (via price) the activities of millions of buyers and
sellers without any need for an expensive bureaucracy of decision makers.
■ Disadvantages – ‘market failures’ (see Chapter 8, p. 278) can result in a misalloca-
tion of resources.

Quote It was the role of prices within the market mechanism that Adam Smith was
referring to when, in his Wealth of Nations in 1776, he observed that each
individual was ‘led by an invisible hand to promote an end which was no part
of his intention’.

■ Pure command economy

■ Governments, not markets, allocate scarce resources of land, labour and capital.
■ Comprehensive plans are drawn up to decide which products are to be produced
and in what quantities.
■ Prices, if they exist, are determined by governments. If there is excess demand at the
ruling price, then ‘rationing’ may be used. If there is excess supply, then unwanted
product may simply be stored or even destroyed.
■ Governments retain ownership of the means of production (little or no private own-
ership).
■ Advantages – production and consumption can be based on ‘social’ rather than
‘private’ needs and wants.
■ Disadvantages – expensive bureaucracy needed to allocate resources; inappropriate
decisions often made by bureaucrats, resulting in excess supply for unwanted
products or excess demand for wanted products.
 ■ Mixed economy
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■ Uses both markets and government intervention to allocate
You can find up-to-date information
scarce resources of land, labour and capital.
on the US economy from the ■ Government intervention can be direct (e.g. nationalised indus-
Economics Statistics Briefing Room of
tries, public sector services) andor indirect (e.g. regulations,
the White House at: http://www.
whitehouse.gov/fsbe/esbr.html
tax policies).
Data on other advanced industrialised ■ Most modern economies are mixed – e.g. around 40% of UK
market economies can be found at:
expenditure and output involves the public sector.
http://www.oecd.org
Data on the transition economies can ■ Advantages – government intervention can help offset various
be found from the European Bank for types of ‘market failure’ (see Chapter 8, p. 282); markets and
Reconstruction and Development
prices can be used to co-ordinate large numbers of independent
website at: www.ebrd.com
decisions.

■ Disadvantages – high taxes may be needed to provide the revenues to support

government intervention; these may reduce incentives and discourage output,
investment and employment.