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Economic Systems

MARKET VS. COMMAND SYSTEMS Critics commonly argue that in a market system the
One way to define economic systems is to classify them rich, who begin with a disproportionately large share of
according to whether they are market systems or com- resources, tend to become richer while the poor, who
mand systems. In a market system, individuals own the begin with a disproportionately small share of resources,
factors of production and individually decide how to use tend to become poorer. They further argue that a govern-
them. The cumulative decisions of these individuals are ment, which is designed to protect private-property rights,
reflected in constantly changing prices, which result from will tend to be exploited by those in power, which tends
the supply and demand for different commodities and, in to be the economically wealthy. These critics argue that a
turn, impact that supply and demand. The prices of those market economy leads to selfish behavior rather than
commodities are signals to everyone within the system socially desirable outcomes.
indicating relative scarcity and abundance. Indeed, it is In contrast, a command system is one in which deci-
the signaling aspect of the price system that provides the sion making is centralized. In a command system, the gov-
information to buyers and sellers about what should be ernment controls the factors of production and makes all
bought and what should be produced. decisions about their use and about the consumption of
In a market system the interaction of supply and output. The central planning unit takes the inputs of the
demand for each good determines what and how much to economy and directs them into outputs in a socially desir-
produce. For example, if the highest price that consumers able manner. This requires a careful balancing between
are willing to pay is less than the lowest cost at which a output goals and available resources.
good can be produced, output will be zero. That does not In a command system the central planners determine
mean that the market system has failed. It merely implies what and how much will be produced by first forecasting
that the demand is not high enough in relation to supply an optimal level of consumption for a future period and
to create a market; however, it might be someday. then specifically allocating resources projected to be suffi-
In a market economy the efficient use of scarce inputs cient to support that level of production. The optimal
determines how output will be produced. Specifically, in a level of production in a command economy is determined
market system, the least-cost production method will have by the central planners and is consistent with government
to be used. If any other method were used, firms would be objectives rather than being a function of consumer
sacrificing potential profit. Any firm that fails to employ desires.
the least-cost technique will find that other firms can As a part of the resource allocation process, the cen-
undercut its price. That is, other firms can choose the tral planners also determine how production will take
least-cost or any lower-cost production method and be place. This process could focus on low-cost production or
able to offer the product at a lower price, while still mak- high quality production or full-employment of relatively
ing a profit. This lower price will induce consumers to inefficient resources or any number of other governmen-
shift purchases from the higher-priced firm to the lower- tal objectives.
priced firm, and inefficient firms will be forced out of Finally, the command system will determine for
business. whom the product is produced. Again, the focus is on
In a market system, individuals make the choice socially desirable objectives. The product can be allocated
about what is purchased; however, ability to pay, as well as based on class, on a queuing process, on a reward system
the consumer’s willingness to purchase the good or serv- for outstanding or loyal performance, or on any other
ice, determine that choice. Who gets what is determined socially-desirable basis for the economy.
by the distribution of money income. In a market system, Critics commonly argue that because planned
a consumer’s ability to pay for consumer products is based economies cannot effectively process as much relevant
on the consumer’s money income. Money income in turn information as a market does, command economic sys-
depends on the quantities, qualities, and types of the var- tems cannot coordinate economic activity or satisfy con-
ious human and non-human resources that the individual sumer demand as well as market forces do. For example,
owns and supplies to the marketplace. It also depends on consider an economic planning board of twenty people
the prices, or payments, for those resources. When you are that must decide how many coats, apartment buildings,
selling your human resources as labor services, your cars, trains, museums, jets, grocery stores, and so forth
money income is based on the wages you can earn in the should be built in the next five years. Where should these
labor market. If you own non-human resources—capital planners begin? How would they forecast the future need
and land, for example—the level of interest and rents that for each of these? Critics argue that, at best, planners
you are paid for your resources will influence the size of would make a guess about what goods and services would
your money income, and thus your ability to buy con- be needed. If they guess wrong, resources would be misal-
sumer products. located and too much or too little production would take

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 221