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Market Economy vs. Command Economy: Overview
Market economies and command economies are opposing systems of economic production. The primary difference is in who controls the factors of production and sets the prices for the products.
In a command economy, the government controls the factors of production such as land, labor, and capital. The government determines what products will be produced and what prices will be set for them. In a market economy, businesses are privately owned, and their decisions on what to produce are based on the profit motive. Prices are set according to the law of supply and demand.
Key Takeaways
- In a market economy, businesses are privately owned, and they decide what to produce.
- In a command economy, a government body determines what products will be produced, how much will be produced, and what their prices will be.
- Most modern nations do not operate purely as command or market economies but incorporate aspects of both.
Market Economy
The activity in a market economy is not organized by a central authority but is determined by the supply and demand for goods and services. Consumer preferences and resource scarcity determine which goods are produced and in what quantity.
The 18th-century economist Adam Smith, in his book The Wealth of Nations, compares market activity to an “invisible hand” that distributes resources to the public.
The prices in a market economy act as signals to producers and consumers, and governments play a minor role in the direction of economic activity through taxes and regulation.
Market economies are closely associated with capitalism. Individuals and businesses own resources and are free to exchange them with each other.
Consumers commonly look out for their best interests, but market economies do not ensure that everyone has access to essential goods, services, or opportunities. Karl Marx, the German economist, argued that a market economy was inherently unequal and unjust because wealth and power would remain with the owners of capital.
Important
John Maynard Keynes, an English economist, believed pure market economies are ill-equipped to respond to recessions and advocated for government intervention to regulate business cycles. That view can be seen in the U.S. Federal Reserve’s mandate to control the supply of money and interest rates.
Command Economy
A command economy is organized by a centralized government that owns most if not all businesses and controls the factors of production. Milton Friedman, an American economist, noted that command economies must inherently limit individual freedom to operate. Macroeconomic and political considerations commonly determine resource allocation.
Officials determine when, where, and how much is produced. Prices are set by the government. Ludwig von Mises, an Austrian economist, argued that command economies are untenable and doomed to fail because no rational prices could emerge without competition and private ownership of the means of production.
Command economies aim to provide the basic necessities of life to all of their people.
Combining Economic Policies
Most market economies and command economies function with elements of both. Cuba has been regarded as a command economy but has made significant market reforms in recent years. In 2021, many businesses were privatized and no longer operate under the authority of the government, a characteristic of a market economy.
The United States, a market economy, temporarily switched to a planned economy during World War II to arm and equip its military while maintaining its production of civilian necessities.
The U.S. today carries elements of a command economy, such as subsidies of some essential products and welfare programs for the poor.
What Are the Advantages of a Market Economy?
In a market economy, prices are set by the decisions of consumers and producers, each acting in their own interests. The profit motive and competition between businesses provide an incentive for producers to deliver the most desirable, cost-effective products at the best price.
How Does Political Climate Influence a Country’s Economy?
The type of economy reflects a country’s political landscape and influences it. Milton Friedman argued that command economies are likely to become authoritarian regimes because economic freedom is closely tied to political freedom.
What Is a Mixed Economy?
A mixed economy combines elements of a market and command economy, with the government regularly intervening in the market to prevent shortages and address economic problems.
What Are the Advantages of a Command Economy?
A command economy allows the government to mobilize a nation’s resources to accomplish critical goals that would be difficult for market factors to resolve alone.
In times of war or crisis, governments may resort to elements of a command economy, such as rationing or price controls, to maintain social stability.
For example, during the COVID-19 pandemic, the U.S. government ordered pharmaceutical companies to begin mass production of tests and vaccines at a volume that would have been unlikely in a purely market-driven system.
The Bottom Line
The primary differences between a market economy and a command economy include resource control, capital ownership, and price determination for goods and services.
A market economy is commonly equated to capitalism, emphasizing private ownership of business and relying on the forces of supply and demand to determine production levels and prices.
In a command economy, governments own the factors of production, control resources, and set prices. Pure command economies are associated with communism.
