Short on time? This page is the recap. For explanations, diagrams and worked examples, use the full study guide.
Recap
- Scarcity forces every society to allocate resources: to choose their uses and who gets the output.
- Every economy must answer what to produce, how to produce it and for whom.
- An economic system has two parts: institutional arrangements (ownership, who decides, laws) and a coordinating mechanism (a central plan or prices in markets).
- The pure command and pure market economies are the two ends of a spectrum. Real economies are mixed and lie between them.
Key relationships
| Command | Market | Mixed | |
|---|---|---|---|
| Ownership | mostly state | mostly private | mostly private, some state |
| Coordinating mechanism | central plan, output targets | prices | mainly prices plus government decisions |
| What? | planners | consumers’ spending | mostly consumers; government chooses some |
| How? | planners assign methods | firms pick the lowest-cost method | firms, within government rules |
| For whom? | planners (rations, set wages) | those willing and able to pay | ability to pay, adjusted by taxes, transfers, public services |
| Strength | fast focus on a priority | good information, strong incentives | combines both |
| Limitation | poor information, weak incentives | unequal outcomes, some goods badly provided | government choices can be wrong or costly |
Least-cost rule (market “how”): total cost = (worker-hours × wage) + (machine-hours × rent). Firms choose the cheaper method, so a high wage pushes firms towards machines and a low wage towards labour.
Assumptions and limits of the models
- No economy is purely command or purely market; the labels mean “closer to that end”.
- The market model assumes competition, property rights and good information.
- The command model assumes planners know what people want and what things cost.
- The models describe how resources are allocated, not whether the result is fair.
Mistakes to avoid
- Saying a market economy has no government at all.
- Describing a system by ownership only and forgetting the coordinating mechanism.
- Treating “for whom” as “who makes it” instead of “who receives it”.
- Saying a command economy escapes scarcity.
- Saying firms alone decide what is produced in a market: consumers’ spending decides which goods earn profits.
Quick self-check
- Which question is answered when a firm chooses machines instead of workers? (How to produce.)
- What coordinates decisions in a market economy? (Prices, through voluntary buying and selling.)
- Method P needs 8 worker-hours and 1 machine-hour; method Q needs 2 worker-hours and 3 machine-hours. The wage is $10 and machine rent is $20 per hour. Which method does a market firm choose? (P = 80 + 20 = $100; Q = 20 + 60 = $80; it chooses Q.)
- Give one limitation of the command model. (Planners lack the information to match output to millions of different wants, so shortages and surpluses appear.)
Next: practice questions.