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Distinction between Market Economy and Centrally Planned Economy

Updated on October 16, 2012
Balanced Economy
Balanced Economy

Distinction between Market Economy and Centrally Planned Economy

The central or basic economic problem can be solved by two ways:

  1. By free interaction of individuals pursuing their objectives as is done in the market or

  2. In a planned manner by some central authority like Government.

Let us discuss about it.

Market Economy

A market-oriented economy also called capitalist economy is one in which all economic activities are organized through the market. A market is a place where buyers and sellers meet together and through free interaction they sell or purchase the goods or services.

Through price mechanism free market economy operates. Price mechanism is a mechanism by which the price of a product or service determined based on the demand and supply. Competition is the characteristic feature of the Market Economy as there is no interference by the Government.

The central problems of 'what, how and for whom to produce' are solved by price mechanism in a market oriented economy. Consumers choice plays an important role in the price determination and the quality and quantity of production. Demand of a product increases the price of that product which is a positive signal for the producers to produce more of that particular product. At the same time decrease in price signals the producers to reduce the production as demand goes down. It is evident that customers look for quality and run after goods which is of good quality. This quality conscious determines the method of production and solve the central problem of 'how to produce'. This market economy system solves the central problem of 'what and how much to produce.'

By adopting those technology of production which reduces the cost of production and by controlling the cost of factor inputs solves the central problem of 'how to produce.' The central problem of 'for whom to produce' can be solved by the free play of market forces which guide the producers how the output produced by factors is distributed among the factors of production in the form of wages, rent, interest and profit.

In a market economy, it is the market price of the commodity which guides the producer to solve the problem of 'what, how and for whom to produce.'

To reduce the disorders like inequalities of price, income, monopolies, unemployment, exploitation of poor by the rich, Government is compelled to intervene in the economy and regulate market mechanism through state control and planning.

Centrally Planned Economy

A centrally planned economy is one in which all important activities are planned and decided by the government or the central planning authority. To choose and the choice is the essence of an economic activity. To plan is to act with a purpose. Here the central authority generally known as planning commission appointed by Government solve the central problems of 'what, how and for whom to produce' by the conscious decisions taken by them.

Planning Commission decides how much should be produced/consumed and which goods are to be produced in the economy within a given period of time. The problem of how to produce is solved by choosing the method of production to be adopted in the factories owned by the government. Since these factories are owned by the Government they decide the compensation for various skills and compensation for other factors of production. This solves the problem of 'for whom to produce'.

It is the Central Planning Authority which solves all the central problems by incorporating the solutions in the plan itself. It is to be noted that China and Soviet Union were centrally planned economies in the past but today they are moving towards the Market System.

In the present there is no economy which is hundred percent market oriented or centrally planned because both the government sector and private sector plays more or less equal roles in the functioning of the economy. Modern economies are mixed economies in which central problems are solved partly through market/price mechanism and partly through direct planning.

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