FREE MARKET ECONOMY
Everyone in this system is motivated by pure self-interest
Firms can sell anything they want.
There is none
Nearly all markets are perfectly competitive.
There is no competition, so there is no price mechanism
A free market economy
Before we look at how the three questions are answered, we must quickly look at some of the characteristics of a free market economy.
Characteristics of this system
1. Ownership: Nearly all of the country's factors of production are owned privately. Although it might make sense to argue that firms own some of the resources, it is private individuals, or groups of individuals, who own the resources. They then rent them out to the firms so that they can produce the goods and services. Richard Branson is in charge of Virgin, but first and foremost he is a private individual who owns the majority of the shares. He could get someone else to run the company. This brings into play one of the government's limited roles. Through the legal system, the government must uphold the property rights of these private individuals.
2. Objectives: Everyone in this system is motivated by pure self-interest. Consumers maximise welfare, firms maximise profits and the private individuals, who own the factors of production, aim to maximise rents (on land), wages (on labour), interest and profit (on capital).
3. Free enterprise: Basically, firms can sell anything they want. They effectively respond to the consumers, who are allowed to buy anything that is sold by the producers. Workers can take on any job they want (this may seem obvious, but wait and see what happens in the command economy).
4. The level of competition: Very high. Basically, it is assumed that nearly every market is a perfectly competitive one, with numerous buyers and sellers and no barriers to entry or exit. Firms are competing desperately for customers and the consumers are competing with each other for the goods on offer.
5. The pricing system: Nearly all markets are perfectly competitive. You may remember that in these circumstances, the price mechanism allocates the economy's resources. The reason why it is called the price' mechanism is because the price acts as a signal and an incentive for producers to act in the required way so as to maximise their gain, which, in turn, optimises the allocation of resources in the whole economy.
A command economy
As with the free market system, before we look at how the three questions are answered, we must quickly look at some of the characteristics of a command economy. Remember that, in complete contrast to the free market economy, a command economy has a very powerful government sector (or 'planners') and the workers and consumers are subordinate.
Characteristics of this system
1. Ownership: Nearly all of the country's factors of production are owned publicly by the government (or the state). The only factor over which the government does not have total control is labour, but as you will see, they certainly have indirect control over the workers.