A planned economy is a type of economic system that stands in contrast to a market economy, where the forces of supply and demand, driven by individual choices and competition, largely determine what is produced, how it is produced, and for whom it is produced. In a planned economy, these decisions are primarily made by a central authority, typically the government.
The central authority, often the government, has significant control over economic activities. It dictates what goods and services should be produced, in what quantities, and at what prices.
2. Public Ownership:
In planned economies, the government or the state typically owns and operates key industries and enterprises. Private ownership and entrepreneurship may be limited or heavily regulated.
3. Allocation of Resources:
Resources, including labor, capital, and natural resources, are allocated based on central planning priorities and objectives, rather than market forces.
4. Price Controls:
Prices of goods and services are often set by the central authority to achieve specific economic and social goals. These prices may not necessarily reflect supply and demand conditions.
5. Limited Consumer Choice:
Consumer choice is restricted, as the range of available products and services is determined by the central authority’s production plans.
6. Bureaucratic Coordination:
A planned economy requires a significant bureaucratic apparatus to coordinate economic activities, enforce regulations, and implement the central plan.
Historical Examples of Planned Economies
Several countries and regions have experimented with planned economies over the years, each with its unique approach and characteristics. Some notable historical examples include:
1. Soviet Union:
The Soviet Union, particularly during the leadership of Joseph Stalin, is one of the most famous examples of a planned economy. The state controlled virtually all economic activities, and collective farms and state-owned enterprises played a dominant role.
2. Maoist China:
Under the leadership of Mao Zedong, China implemented a planned economy known as the Great Leap Forward. The government aimed to rapidly transform China into an industrial powerhouse through collectivization and central planning.
3. North Korea:
North Korea continues to operate as a centrally planned economy, with the government exerting control over nearly all aspects of economic life, including agriculture, industry, and trade.
4. Cuba:
Cuba has maintained a planned economy, with most major industries and services owned and operated by the state. The government also sets prices and controls foreign trade.
5. Eastern Bloc Countries:
Countries in Eastern Europe, including East Germany, Poland, and Hungary, operated planned economies during the Cold War under the influence of the Soviet Union.
Advantages of a Planned Economy
A planned economy offers several potential advantages:
1. Economic Stability:
Central planning can help stabilize the economy by avoiding extreme fluctuations in output, employment, and prices.
2. Income Equality:
Planned economies often prioritize income equality and social welfare, leading to reduced income disparities compared to market economies.
3. Resource Allocation:
Resources can be allocated strategically to prioritize sectors such as education, healthcare, and infrastructure development.
4. Long-Term Planning:
Planned economies can engage in long-term economic planning and invest in projects with significant societal benefits, even if they have extended payback periods.
5. Control over Key Industries:
Governments can exert direct control over essential industries, ensuring that critical services are accessible to the entire population.
Disadvantages of a Planned Economy
Despite potential advantages, planned economies face significant drawbacks:
1. Inefficiency:
Centralized decision-making can lead to inefficiencies, as resource allocation may not align with actual consumer demand or changing market conditions.
2. Lack of Innovation:
The absence of market competition can stifle innovation and technological advancement, as there may be little incentive to improve products or processes.
3. Bureaucratic Inefficiency:
Bureaucratic coordination in planned economies can result in inefficiencies, corruption, and a lack of responsiveness to consumer preferences.
4. Shortages and Surpluses:
Centralized planning may lead to shortages of certain goods and surpluses of others, as planners may not accurately predict demand.
5. Consumer Choice:
Planned economies often limit consumer choice, as the range of available products and services is determined by central authorities.
6. Lack of Incentives:
Without the profit motive, workers and entrepreneurs may lack incentives to be productive and innovative.
Contemporary Perspectives on Planned Economies
In recent decades, the number of countries operating fully planned economies has dwindled. However, aspects of central planning can still be found in various mixed economies, where governments play a significant role in certain sectors, such as healthcare, education, and infrastructure.
Contemporary perspectives on planned economies often involve mixed economic systems that combine elements of central planning with market-oriented features. For example, China has transitioned from a centrally planned economy to a “socialist market economy with Chinese characteristics,” where state-owned enterprises coexist with a dynamic private sector.
Conclusion
Planned economies, characterized by centralized decision-making and public ownership of key industries, have played a prominent role in economic history. While they offer potential advantages such as income equality and economic stability, they also face significant challenges, including inefficiency and limited innovation.
In the modern world, few countries adhere strictly to planned economies, preferring mixed economic systems that combine elements of central planning with market forces. The choice of economic system ultimately depends on a nation’s historical, cultural, and political context, as well as its goals for economic development and social welfare.
The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.
Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.
When there is an increased price of goods and services over a long period, it is called inflation. In these times, currency shows less potential to buy products and services. Thus, general prices of goods and services increase. Consequently, decreases in the purchasing power of currency is called inflation.
Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.
Autarky comes from the Greek words autos (self)and arkein (to suffice) and in essence, describes a general state of self-sufficiency. However, the term is most commonly used to describe the economic system of a nation that can operate without support from the economic systems of other nations. Autarky, therefore, is an economic system characterized by self-sufficiency and limited trade with international partners.
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.
An oligopsony is a market form characterized by the presence of only a small number of buyers. These buyers have market power and can lower the price of a good or service because of a lack of competition. In other words, the seller loses its bargaining power because it is unable to find a buyer outside of the oligopsony that is willing to pay a better price.
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage. Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
The paradox of thrift was popularised by British economist John Maynard Keynes and is a central component of Keynesian economics. Proponents of Keynesian economics believe the proper response to a recession is more spending, more risk-taking, and less saving. They also believe that spending, otherwise known as consumption, drives economic growth. The paradox of thrift, therefore, is an economic theory arguing that personal savings are a net drag on the economy during a recession.
In simplistic terms, the circular flow model describes the mutually beneficial exchange of money between the two most vital parts of an economy: households, firms and how money moves between them. The circular flow model describes money as it moves through various aspects of society in a cyclical process.
Trade deficits occur when a country’s imports outweigh its exports over a specific period. Experts also refer to this as a negative balance of trade. Most of the time, trade balances are calculated based on a variety of different categories.
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.
Rational choice theory states that an individual uses rational calculations to make rational choices that are most in line with their personal preferences. Rational choice theory refers to a set of guidelines that explain economic and social behavior. The theory has two underlying assumptions, which are completeness (individuals have access to a set of alternatives among they can equally choose) and transitivity.
The peer-to-peer (P2P) economy is one where buyers and sellers interact directly without the need for an intermediary third party or other business. The peer-to-peer economy is a business model where two individuals buy and sell products and services directly. In a peer-to-peer company, the seller has the ability to create the product or offer the service themselves.
The term “knowledge economy” was first coined in the 1960s by Peter Drucker. The management consultant used the term to describe a shift from traditional economies, where there was a reliance on unskilled labor and primary production, to economies reliant on service industries and jobs requiring more thinking and data analysis. The knowledge economy is a system of consumption and production based on knowledge-intensive activities that contribute to scientific and technical innovation.
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.
How do you protect your rights as a worker? Who is there to help defend you against unfair and unjust work conditions? Both of these questions have an answer, and it’s a solution that many are familiar with. The answer is a labor union. From construction to teaching, there are labor unions out there for just about any field of work.
The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”
Glocalization is a portmanteau of the words “globalization” and “localization.” It is a concept that describes a globally developed and distributed product or service that is also adjusted to be suitable for sale in the local market. With the rise of the digital economy, brands now can go global by building a local footprint.
Market fragmentation is most commonly seen in growing markets, which fragment and break away from the parent market to become self-sustaining markets with different products and services. Market fragmentation is a concept suggesting that all markets are diverse and fragment into distinct customer groups over time.
The L-shaped recovery refers to an economy that declines steeply and then flatlines with weak or no growth. On a graph plotting GDP against time, this precipitous fall combined with a long period of stagnation looks like the letter “L”. The L-shaped recovery is sometimes called an L-shaped recession because the economy does not return to trend line growth. The L-shaped recovery, therefore, is a recession shape used by economists to describe different types of recessions and their subsequent recoveries. In an L-shaped recovery, the economy is characterized by a severe recession with high unemployment and near-zero economic growth.
Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846. Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.
The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further.
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
Discover more from FourWeekMBA
Subscribe now to keep reading and get access to the full archive.
