A) The distinction between free market, mixed and command economies

In a free market economy, resources are mainly allocated through the decisions of consumers and firms. Businesses aim to maximise profit, while consumers decide which goods and services they want to buy.

In a command economy, the state has much greater control over the allocation of resources. The government can decide what should be produced and how resources should be distributed.

A mixed economy contains elements of both systems. Market forces allocate many resources, but the government also intervenes and provides certain goods and services.

B) Adam Smith, Friedrich Hayek and Karl Marx

Adam Smith

Adam Smith was a key economist during the 1700s and was best known for his book The Wealth of Nations. He argued in favour of free markets and believed that resources could be efficiently allocated when people acted in their own self-interest.

Smith described the market forces that help coordinate consumers and producers as the invisible hand. For example, if demand for a good increases, its price may rise and give firms an incentive to increase production.

Friedrich Hayek

Friedrich Hayek also supported free markets. He believed that consumers and producers often have better information about their own preferences and circumstances than the state.

Karl Marx

Karl Marx was a critic of capitalism and free market economies. He argued that capitalism could lead to the exploitation of workers and increasing inequality.

C) Advantages and disadvantages of a free market economy

Advantages

• Choice – Firms have an incentive to produce goods and services that consumers demand because they can earn profit from doing so. This can increase the range of products available to consumers.
• Competition – Competition between firms can encourage lower prices and better quality, benefiting consumers.

Disadvantage

• Externalities and missing markets – Firms acting in their own interests may not take all social costs and benefits into account. Some goods, such as public goods, may also not be provided by the free market.

D) Advantages and disadvantages of a command economy

Advantage

• Provision of public goods – The state can provide goods and services even where it would not be profitable for a private firm to do so.

Disadvantage

• Lack of information – The state may not have enough information about what consumers actually want. This can lead to too much of some goods being produced and too little of others.

E) The role of the state in a mixed economy

In a mixed economy, both markets and the state play a role in allocating resources. For example, the government may provide public goods which would otherwise not be supplied by the free market.

What the full guide adds

For this topic, the full AS guide also covers:

• Adam Smith, Friedrich Hayek and Karl Marx in greater depth, including further explanation of the invisible hand, Hayek’s views on information and resource allocation, and Marx’s criticisms of capitalism.
• Additional advantages of free markets, including efficiency, market equilibrium and responsiveness to changes in demand.
• Further disadvantages of free markets, including profit maximisation and the risk of monopolies.
• Additional advantages and disadvantages of command economies, including greater equality, prevention of monopolies, inefficient resource allocation and lack of innovation.
• A fuller explanation of the role of the state in a mixed economy, including public goods, taxation and the redistribution of income.