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Economics-Command Economy

ECONOMICS 

What goods or services to produce? How best to produce goods and services? Who are the final users of those goods and services? Which products to buy or to sell? What to give up to maximize our satisfaction? Those are the type of questions individuals, organizations and societies mostly face .Every single day, about hundreds of billions of decisions are made by people all over the world. Because human, natural, and capital resources are scarce, individuals, firms, and governments must make economic choices about their alternatives use. There is no one definition of economics, but Lord Robbins defined it as ‘the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses...’ This work will analyse this problem of scarcity and choice by focusing on some economic concepts: opportunity cost, public goods, perfect competition, and command economy.

Opportunity cost

Opportunity cost is the highest –valued alternative people have to sacrifice because of the decision they took. When a product is scarce, choosing to use it in one way means giving up some other uses. The value of the alternative you give up is the opportunity cost. It can also be defined as ‘the value of best forgone alternative’. A CEO of a company C needs to hire some managers. Let’s assume each manager must do only one work. Work A is worth $100,000 to the owner, Work B is worth $50,000 to him and Work C is worth $30,000. The owner hires 2 managers, one for work A and one for work C. What is the opportunity cost of work A and work C? The opportunity cost of Work A and C is the value of the forgone work that would have been done, which in this case is work B. So the opportunity cost of A is 50,000$ and for C is also $50,000.

PPF (Production-Possibility Frontier) describe the limit of what can be produced; it separates the achievable from the unachievable. Production can be made at any point inside the PPF area (area U) or on the PPF. Points outside the frontier (area I) are unachievable; it describes point that cannot be satisfied.

Let’s consider two products A and B:

Possibilities

A (butter)

B (Guns)

U

0

15

V

1

14

W

2

12

X

3

9

Y

4

5

Z

5

0

This table list some quantities of A and B that can be produced in a day.

x-axis----quantity of A                    y-axis----quantity of B

Row V tells us that if we produce no A, the maximum quantity of B that can be produced is 15. When we move along the PPF from W to X, the production of A is 3B. The inverse of 3 is 1/3, so if we decrease the production of A and increase the production of B by moving from X to W, the opportunity cost of a B must be 1/3 of A. The opportunity of A increases as the quantity of B produced increase. Also the Opportunity cost of B increases as the quantity of A produced increases. This phenomenon of increasing opportunity cost is reflected in the shape of the PPF, it is bowed outward; when a large quantity of B and a small quantity of A are produced (between point U and V) the frontier has a gentle slope; when a large quantity of A and a small quantity of B are produced (between point Y and Z) the frontier is steep. The PPF is bowed outward because resources are not equally productive in all activities, and the PPF is a straight line when the opportunity cost is constant.

Name

 

Public Goods

 A public good is a good that is non-rivalrous (the consumption of the good by one individual does not diminish its availability for the use of others) and non-excludable (an individual cannot be denied the opportunity of consuming the good whether he pays for it or not). Paul A. Samuelson defined a public good as ‘... goods which all enjoy in common in the sense that each individual’s consumption of such good leads to no subtraction from any other individuals’ consumption of that good...’ (Samuelson,1954: 387). Graphically, non –rivalry means that if each individual has a demand curve for a public good, then the individual demand curve are summed vertically (because all consumers can enjoy the same) to get the aggregate demand curve.

Name

 Examples of public goods : law enforcement, public fireworks, lighthouses, clean air,, street lights, defence (one person in an area is defended from foreign attack and other people in that same area are likely defended also; this make it difficult to charge people for defence)... One of the major causes of market failure involving public goods is non-excludability; individuals cannot be prevented to consume them, as a result many people would consume the service without paying for it; this is called free-rider problem. Consumers can take advantage of public goods without contributing sufficiently for it.

Perfect competition

The National Association of Business Economists (US) identified 7 features of a perfect competition (1977: 3)

Large number but small size of buyers and sellers: the number of buyers and sellers of a product is very large under perfect competition, but each buyer and each seller is so small in comparison with the entire market of the product, that by changing the quantity of the product bought and sold by him, he cannot influence its price;

Homogenous Products: all sellers sell homogenous units of a given product;

Perfect Knowledge: buyers and sellers are fully aware of the price of the product prevailing in the market. Because of this knowledge and awareness, all sellers will charge one price for the products;

Free entry and exit of firms: any new firm can enter any industry and any old firm can withdraw from any industry;

Free from Checks: buyers and sellers are free from any checks or restriction with regard to their buying or selling of any product;

Perfect Mobility: all firms are assumed to have equal access to resources;

Same Price: each seller charges the same price for the same product. Price is determined by the industry. All firms have to sell their product at this price. Firms under a perfect competition are price-taker not price maker. The price taker cannot control the price of the product it sells but it simply takes the market price as given

perfect competition example

There are number of perfect competition economics examples in the world but no one is as prominent to give examples in books and journals.

In the short run firm can make profit; but in the long run, positive profit cannot be sustained. The arrival of new firms or expansion of existing firms in the market causes the demand curve of each firm to shift downward, bringing down at the same time the price, the average revenue and marginal revenue curve. The final outcome is that, in the long run, the firm will make only normal profit (zero economic profit). Its horizontal demand curve will touch its average total cost curve at its lowest point

 

In the diagram below, the firm shown has high short run costs such that the ruling market price is below the average total cost curve. At the profit maximizing level of output, the firm is making an economic loss (or sub-normal profits). The addition of new suppliers causes an outward shift in the market supply curve. This is shown in the diagram below.

 

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Making the assumption that the market demand curve remains unchanged, higher market supply will reduce the equilibrium market price until the price = long run average cost. At this point each firm is making normal profits only. There is no further incentive for movement of firms in and out of the industry and a long-run equilibrium has been established. Long-run equilibrium: AR2=MR2=AC=MC

The entry of new firms shifts the market supply curve to MS2 and drives down the market price to P2. At the profit-maximizing output level Q3 only normal profits are being made. There is no incentive for firms to enter or leave the industry. Thus a long-run equilibrium is established.

Command economy

In a command economy, the government makes all decision relating to resources allocation, production, distribution … China and ex-USSR, North Korea and Cuba are examples of Command economy. Firms receive guidance and directives from the government regarding production capacity, volume, modes of production. The government of the Soviet Union during the 1930 forced the share of the GNP dedicated to private consumption to fall from 80% to 50% (Brabant, 1991, p16)

Features of command economy:

1- Command Economy is more stable, guaranteeing constant exploitation of the existing resources. It is least affected by financial downturns and inflations; 2-In a carefully planned Command Economic system, both surplus production and unemployment rates remain at a reasonable level; 3- Encourages investments in long-standing project-related infrastructures without any possibility of financial recessions; 4-Command Economic system prefers deliberate planning of the entire money-making process for better results, such economic planning in the long run proves beneficial to improve the economic conditions of a country; 5-Command Economy emphasizes more on collective benefits, rather than the requirements of a single individual. Under such circumstances, rewards, wages and other monetary benefits like bonus are distributed on the basis of the joint rendering of services, eradicating the profit-making at individual levels.

Advantages:  any wasteful competition is avoided, more equal distribution of income and wealth, and control of inflation, eliminate the individual profit motives, low unemployment. Disadvantages: little freedom, misjudgment of the preference of the consumers, overproduction of certain products and underproduction of others, lack of competition between companies, lack of variety and quality of products (little innovation) or misallocation of resources, lack of motivation among management and workers since individuals do not own the businesses, benefit directly from the profit, lack of entrepreneurship. It is because of the failings of the command economy that most countries today are moving towards a mixed economy. Mixed economy aims to combine the merits of both the market and the command economies; the mixed economy allows the market to operate, with government intervening in the economy only where the market fails. Mixed economy is an economy where the decisions about what, how, and for whom to produce are partly made via the market and partly by the government (Ison &Wall, 2006: 12). Some major examples of this economy are United States, Japan… An advantage of this economy is that a country can adjust to change easily, great variety of products and services for consumers. E.g. a government can fixed a minimum wages but companies are allowed to pay more to their employees.

 

 

There are only limited amount of resources available to produce the unlimited amount of products consumers desire. Because of the scarcity of resources, concept such as opportunity cost, perfect competition, public goods and command economy are very useful not only for the economist but also for firms, individuals, governments... They provide them a information about how to make decisions and how to make a best use of the scarce resources available to them.   

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