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

Market Economy vs. Command Economy: An Overview

Market economies and command economies occupy two polar extremes in the organization of economic activity. The primary differences lie in the division of labor, or factors of production, and the mechanisms that determine prices. The activity in a market economy is unplanned; it is not organized by any central authority but is determined by the supply and demand of goods and services. The United States, England, and Japan are all examples of market economies.

Alternatively, a command economy is organized by a centralized government that owns most, if not all, businesses and whose officials direct all the factors of production. China, North Korea, and the former Soviet Union are all examples of command economies. In reality, all economies blend some combination of market and command economies.

Key Takeaways

  • Market economies utilize private ownership as the means of production and voluntary exchanges/contracts.
  • In a command economy, governments own the factors of production such as land, capital, and resources.
  • Most nations operate largely as a command or market economy but all include aspects of the other.
  • The type of economy also influences the political and social landscape of a nation, with command economies being more authoritarian and market economies allowing for more personal freedoms.

Market Economy

The two fundamental aspects of market economies are private ownership of the means of production and voluntary exchanges/contracts.

The most common title associated with a market economy is capitalism. Individuals and businesses own the resources and are free to exchange and contract with each other without a decree from government authority. The collective term for these uncoordinated exchanges is the "market."

Prices arise naturally in a market economy based on supply and demand.

Consumer preferences and resource scarcity determine which goods are produced and in what quantity; the prices in a market economy act as signals to producers and consumers who use these price signals to help make decisions. Governments play a minor role in the direction of economic activity.

Businesses in a market economy are expected to regulate their behavior, while consumers are expected to look out for their own best interests and protect themselves from fraud and abuse. Market economies are not concerned with ensuring that less fortunate people have access to essential goods and services or opportunities.

Karl Marx, a German philosopher, argued that a market economy was inherently unequal and unjust because power would be concentrated in the hands of the owners of capital. Marx popularized the term capitalism.

John Maynard Keynes, an English economist, believed that pure market economies were unable to effectively respond to major recessions and instead advocated for major government intervention to regulate business cycles.

Command Economy

Under a command economy, governments own the factors of production such as land, capital, and resources, and government officials determine when, where, and how much is produced. This is also sometimes referred to as a planned economy. The most famous contemporary example of a command economy was that of the former Soviet Union, which operated under a communist system.

Since decision-making is centralized in a command economy, the government controls all of the supply and sets all of the demand. Prices cannot arise naturally like in a market economy, so prices in the economy must be set by government officials.

In a command economy, macroeconomic and political considerations determine resource allocation, whereas, in a market economy, the profits and losses of individuals and firms determine resource allocation. Command economies are concerned with providing basic necessities and opportunities to all members.

Ludwig von Mises, an Austrian economist, argued that command economies were untenable and doomed to fail because no rational prices could emerge without competing, private ownership of the means of production. This would lead to massive shortages and surpluses.

Milton Friedman, an American economist, noted that command economies must limit individual freedom to operate. He also believed that economic decisions in a command economy would be made based on the political self-interest of government officials and not promote economic growth.

Special Considerations

Most market economies and command economies today function with elements of both. For example, Cuba has traditionally been a command economy but has made significant economic reforms to improve the condition of the nation. Many businesses have been privatized and no longer operate under the authority of the government, which is a characteristic of a market economy.

Conversely, the United States, which is a market economy, switched to a planned economy to mobilize during World War II. The U.S. also has command economy elements, such as in medical services provided to seniors.

Traditionally, the type of economy has also determined the political and social landscape of a nation. Command economies have been associated with authoritarian regimes that limit personal freedoms, as Milton Friedman stated. Market economies tend to be democracies that allow for almost total personal freedom.