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What are the four functions of an economic system? Contrast the way in which the market economy and planned economy attempt to solve the economic problem.

By AzTeK Mar 03, 2005 976 Words
The four functions of an economic system are what to produce, how much to produce, how to produce and whom to distribute to.

The market economy is one that is controlled by the people and there is little government intervention. It is also known as a free enterprise economy.

The planned economy is one that is controlled by the government and there is a lot of government intervention into the way in which the economy runs.

They both try and solve the economic problem of trying to satisfy mans unlimited wants with relatively scarce resources in different ways.

The market economy tries to solve the economic problem by letting demand and supply equal price. So therefore the more people that want it, the higher the price will go up until price matches supply. This tries to solve the economic problem by rather letting consumers themselves figuring out how much they are prepared to pay for items. Therefore consumers need to work out how much they are willing to pay for their own products.

The planned economy however is all determined by the government so the government says how much is produced etc. and controls all the economic priorities, resources and allocates production.

What to produce refers to what type of product you are going to produce with your allocated resources. Sometimes you have to make a choice between what you are producing and this is referred to as the opportunity cost. The choice you have to make to allocate your resources.

In a market economy the demand chooses where these resources go and the market decides what to produce.

However in a planned economy the government determines the allocation of resources and production.

How much to produce refers to the quantity that is going to be produced with the use of the available resources.

If you make too much, rather have a lot of supply and little demand then you are not going to sell your products well and to sell your products your price will have to be quite low. If you don't make enough and people want your product then you can make your price higher. If you have a lot of stock and people want to buy your product then you can have your price in between. If you have lots of demand, not enough supply then you aren't producing enough.

In the market economy supply and demand are controlled by the people, or the market. The pricing is determined through the pricing mechanism, which is the automated function that determines price in relation to supply and demand.

In the planed economy the government determines the factors involved with production and sets the price itself. So the government can make products readily available to people by setting a low price or it can give the products a higher price so not many people will want to buy them. For example the government may charge more tax on big cars so people will rather drive a small car, therefore reducing the environmental impact their vehicle has on the nation on a whole.

How to produce refers to the technologically available. What are the methods you will use in the process of production? How will you transform your natural or raw resources into your produced means of production?

By using the latest technology your product may have a superior quality but you might have to charge more for it to cover the extra work involved in the production process.

The market economy will demand the level of technology that will be used, and the government economy will have the level of technology to be used determined by the government.

For example: in both cases if a new technology comes along and the government thinks it will reduce the environmental impact cars have on the environment then it might make it mandatory for all car makers to have this new technology implemented. However in a market economy the consumers may decide this new technology will make cars more expensive and they are not so concerned about the environment so they will not make it mandatory but rather they will choose whether they want to drive environmentally friendly cars or cars that are cheaper but pollute more.

Whom to distribute to refers to whom to give your finished products to. Do you want to export all your finished products so as to raise income through exports, or do you want to keep all your finished products in your own country so your own people can use these to improve their own quality of life.

In the market economy it will be distributed to where there is a stronger demand. If many people in the home market want it, then most of the sales will be in the home market, however if demand in the home market dies down, then exports to the foreign sector will become a possibility.

In a planned economy the government will allocate where the finished products will go and will either keep it all for its own nation or send it all overseas to raise revenue.

It is in these four functions of an economic system that the planned economy and market economy try to solve the economic problem in different ways, of mans unlimited wants with relatively scarce resources.

Whilst they are similar in some ways of trying to get the best out of their product and market, they differ in many ways.

That is, they both have different ways of figuring out what to produce, how much to produce, how to produce and who to produce to

In a planned economy everything is controlled by the government, in a market economy the people or market controls everything. There is a mixture of both which can be likened to Australia and this is called a market economy.

In conclusion, although these two different economies have very different strategies, they both work towards the ultimate goal of trying to solve mans unlimited wants with relatively scarce resources.

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