Comparative Systems

1. Comparative Systems Market Economy vs. Command Economy

2. The Price System • Command Economy – Government plans how and what to produce. It is enforced by law. • Market Economy – Individuals plan and laws protect their transactions.

3. A competitive market: • Has many producers and consumers. • Consumers and producers are both price takers. • Two Exceptions: • If a product only has a single producers that producers affects the market price when deciding how much to sell. • If all producers acted together they could affect market price.

4. Information, Rationing, and Motivation in a Market Economy • The price increase will signal that apartments are more valuable. • The price system will automatically ration available supply to consumers impersonally. Those that are willing to pay the most for a good will obtain it. • The higher price informs producers of the increased scarcity of apartments and the possibility of earning profits motivates producers to build more apartments.

5. Information, Rationing, and Motivation in a Command Economy • Governments are often unwilling to increase prices even if the demand increases. Adjustments are costly politically and in terms of planning. • If prices aren’t flexible then excess demand persists. • Increases in production is undermined because producers rarely share in the economic profits. • Central planners can order more production but are penalized if increased demand is not permanent. Therefore they often opt for inaction. • Motivation for change is often political rather than economic.

6. Systems and Coordination • Market Systems • Prices fall in response to excess supply and rises in response to excess demand so as to equate the quantity demanded and supplied of a good. • Coordinates the interdependent actions of specialized producers without a legally imposed central plan. • Fosters the division of labor that is responsible for increasing the “wealth of nations”.

7. Command Economy systems • Have great difficulty in coordinating economic activity. • Lack a market economy’s ability to automatically and inexpensively collect information about consumer wants and production capabilities. • Cannot automatically and inexpensively provide incentives and motivation for people to make wealth-promoting decisions.

8. Five Pieces of a Market Economic System • Reasonably stable prices and a well-functioning monetary system that facilitates voluntary exchange. • A system of private property and property rights defined, established, and protected by law. • Market incentives that are generated by a price system whose rewards and penalties motivate decision makers. • Flexible prices that fluctuate in response to individual’s voluntary decisions and exchanges (market exchange). • A legal system that is broadly obeyed and a culture that generates a climate of trust.

9. Problems with Transition • Explosion of suppressed inflation. • In Hungary annual inflation rate rose to more than 30%. Ukraine experienced inflation at a rate of 500% in the early 1990s. • Exposure of hidden unemployment. • Decreases in production. • Difficulty in providing monetary framework for market transactions. • Russian businesses began to pay bills and taxes with what they produced. 70% of payments collected by Russian industries were in non-monetary form in 1998 or “payment in kind”/direct barter.

10. Requirements for the Creation of Private Property • Creation of private property rights. • Requires enticing entrepreneurs to start new businesses. • Transferring of State Owned Enterprises (SOEs) to private ownership. • Laws protecting corporate shareholders. • Establishment of modern bankruptcy laws.

11. Honesty and Trust • Countries must develop and enforce a system of contract, criminal, property, and tort law to carry out its economic transformation. • Corruption, in the form of bribes, illegal transfer of state-owned assets to private hands, and use of the government for private gain, must be controlled.

12. Conclusion • Almost all of the transition economies have freed most prices, but they are reluctant to free the prices of necessities, such as food and shelter. • The transitional economies recognize the need to improve incentives but differ in their willingness to adopt market incentives.