Market Economy vs. Command Economy: What’s the Difference?

Market economies and command economies are opposing systems of economic production. The primary differences surround who controls the factors of production and how prices are determined.

In a command economy, the government controls the factors of production, and determines what to produce and what price to sell it for. In a market economy, businesses are privately owned, and their decisions are based on the profit motive. Prices are set by supply and demand.

Key Takeaways

• In a market economy, businesses are privately owned, and they decide what to produce based on the profit motive.
• In a command economy, a government body controls the factors of production, and determines how much to produce and what price to sell it for.
• In a market economy, prices are determined by supply and demand.
• Most nations do not operate as a purely command or market economy, but all include 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 of 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 with each other without permission from government authorities.

Consumers commonly look out for their best interests, and market economies do not ensure everyone has access to essential goods, services, or opportunities. Karl Marx, a 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 were ill-equipped to respond to recessions and advocated for government intervention to regulate business cycles.

Command Economy

A command economy is organized by a centralized government that owns most if not all, businesses and where government officials direct 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. Because the market and supply and demand do not determine prices, prices are set by the government. Ludwig von Mises, an Austrian economist, argued that command economies were 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 standard necessities and opportunities to all members. North Korea is an example of a command economy, although most global economies operate as a mixed economic system with features of a command economy and a free-market system.

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 2021, many businesses were privatized and no longer operate under the authority of the government, a characteristic of a market economy.

Conversely, the United States, a market economy, switched to a planned economy to mobilize during World War II. The U.S. also carries elements of a command economy, such as subsidies and welfare programs.

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 self-interest. 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 may also influence a country’s political landscape. Milton Friedman argued that command economies were likely to become authoritarian regimes because economic freedom is closely tied to political freedom.

What Is a Mixed Economy?

A mixed economy combines the 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 social goals that would be difficult for market factors to resolve alone. In times of war or crisis, may 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 Covid tests and vaccines, in a volume that was unobtainable for purely market-driven actors.

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, highlighting private ownership and the forces of supply and demand. In a command economy, governments own the factors of production, control resources, and set prices.

Read the original article on Investopedia.