resource allocation in these economic systems

Resource Allocation in Different Economic Systems

Learning Objective

By the end of this lesson students should be able to:

• Explain how each economic system answers the three fundamental questions – what to produce, how to produce it and for whom it is produced – and link these decisions to the allocation mechanism used.
• Analyse the strengths and weaknesses of each allocation mechanism, paying particular attention to efficiency/inefficiency and equality/equity.
• Apply the concepts to a range of real‑world examples, including a low‑income country, and evaluate the policy implications.

Key Concept

Resource allocation is the process by which a society decides what to produce, how to produce it and for whom it is produced. The mechanism used to make these decisions differs across economic systems and determines the degree of efficiency, equity and the role of government.

1. Market (Capitalist) Economy

Decision‑making unit (answers to the three fundamental questions)

• What – Households express preferences through demand; firms respond by choosing the quantity of each good to supply.
• How – Firms select production techniques that minimise cost, guided by the profit motive.
• For whom – Distribution is determined by individuals’ ability and willingness to pay (i.e., income and preferences).

Allocation mechanism

Prices act as signals of scarcity and consumer preferences. When a price rises, quantity demanded falls and quantity supplied rises, moving the market toward equilibrium where Q_d = Q_s.

Core ideas (verbal + optional extension)

• Consumer choice (extension): max U(Q) subject to P·Q ≤ I – the consumer picks the bundle that gives the highest utility within the budget.
• Producer choice (extension): max π = P·Q – C(Q) – the firm produces where marginal cost (MC) equals price (P), ensuring resources are used where they add the most value.
• For AS‑Level teaching, simply state: “Consumers buy the combination of goods that gives them the most satisfaction for their income; firms produce up to the point where the cost of making one more unit equals the price they receive.”

Strengths & Weaknesses (linked to syllabus key concepts)

• Strengths
  • High allocative efficiency – price reflects marginal cost and marginal benefit.
  • Innovation incentives – profit motive drives research, development and product variety.
  • Consumer sovereignty – choices reflect individual preferences.
• Weaknesses
  • Market failures (externalities, public‑good under‑provision).
  • Potential for inequality – distribution depends on income (equity issue).
  • Information asymmetry can lead to sub‑optimal outcomes.

Real‑world examples

• United Kingdom – Predominantly market‑driven; the state provides universal health (NHS) and publicly funded education.
• Kenya (low‑income country) – Market mechanisms dominate most goods and services, but limited access to finance and weak institutions create inefficiencies and equity concerns.

2. Command (Planned) Economy

Decision‑making unit (answers to the three fundamental questions)

• What – Central planner sets production targets for each good.
• How – The planner allocates inputs and decides on technology, usually to meet macro‑economic goals.
• For whom – Distribution is based on egalitarian principles or social priorities defined by the state.

Allocation mechanism

The state determines quantities and (often administered) prices through a planning programme. Resources are allocated by solving a cost‑minimisation problem subject to the available supply of inputs.

Illustrative numeric example (simplified)

Suppose a planner has 100 tons of steel to allocate between cars and trucks. The cost of producing one car is 1 ton of steel, the cost of one truck is 2 tons. If the planner wishes to minimise total cost while producing at least 30 cars, the problem is:

Minimise  C = 1·Ccars + 2·Ctrucks  
subject to  Ccars + 2·Ctrucks ≤ 100  
            Ccars ≥ 30

Solving gives the cheapest feasible mix (e.g., 30 cars and 35 trucks). The example shows how the planner’s decision is a constrained optimisation, but the algebraic formulation is not required for AS‑Level.

Strengths & Weaknesses (linked to syllabus key concepts)

• Strengths
  • Ability to mobilise resources quickly for large‑scale projects (e.g., infrastructure, defence).
  • Potential to achieve greater equity if distribution is deliberately equalising.
• Weaknesses
  • Information problem – planners cannot acquire the dispersed, tacit knowledge that markets obtain through price signals.
  • Incentive problem – lack of profit motive reduces motivation for efficiency and innovation.
  • Often leads to shortages or surpluses because quantities are fixed administratively.

Real‑world examples

• North Korea – Highly centralised command economy with state‑owned enterprises and administratively set prices.
• Former Soviet Union (pre‑1991) – Central planning of heavy industry, agriculture and defence.

3. Mixed Economy

Decision‑making unit (answers to the three fundamental questions)

• What – Primarily decided by households and firms; the state intervenes in sectors where market outcomes are judged sub‑optimal (e.g., health, education, defence).
• How – Firms choose production techniques; the government may direct R&D, set standards, or subsidise particular technologies.
• For whom – Distribution is a blend of market‑determined incomes and state‑provided safety nets (welfare, public services).

Allocation mechanism

The market allocates most goods and services through the price mechanism, while the government corrects market failures, provides public goods, and redistributes income through taxation and welfare transfers. The “mix” varies: a high‑tax, high‑welfare state (e.g., Sweden) versus a low‑tax, liberal market (e.g., United Kingdom).

Government failure (key syllabus concept)

• Rent‑seeking – firms lobby for subsidies or protection that do not increase overall welfare.
• Bureaucratic inefficiency – public provision can be more costly than private provision because of lack of competition.
• Policy distortion – taxes and regulations may create dead‑weight losses, reducing allocative efficiency.

Strengths & Weaknesses (linked to syllabus key concepts)

• Strengths
  • Combines market efficiency with state intervention to address externalities and equity.
  • Flexibility – the degree of intervention can be adjusted to changing economic conditions.
• Weaknesses
  • Risk of government failure (inefficient public provision, rent‑seeking).
  • Policy distortion – taxes and regulations may create dead‑weight losses.
  • Complexity in coordination between public and private sectors.

Real‑world examples

• Sweden – High‑tax, high‑welfare mixed economy; extensive public services coexist with a competitive private sector.
• Vietnam – Transitioning mixed economy; market mechanisms dominate most goods, but the state retains control over strategic sectors such as telecommunications and energy.

Equilibrium and Disequilibrium

• Market equilibrium – The point where quantity demanded equals quantity supplied (Q_d = Q_s) at the market price. At this point resources are allocated efficiently (no excess supply or shortage).
• Disequilibrium – Occurs when price is above or below the equilibrium level, leading to either a surplus (excess supply) or a shortage (excess demand). In a command economy, disequilibrium is common because quantities are set administratively rather than by price.
• Understanding equilibrium helps students explain why price changes move an economy toward a more efficient allocation, a key idea in AS‑Level Topic 4 (Market Failure) and Topic 5 (Macroeconomic Policy).

Comparison of Allocation Mechanisms

Aspect	Market Economy	Command Economy	Mixed Economy
Decision‑making unit (what, how, for whom)	Households & firms – price signals decide all three questions.	Central planner – targets set administratively for all three questions.	Both market participants and government – market decides most goods; state intervenes where needed.
Role of price	Primary signal of scarcity & consumer preferences.	Often fixed or absent; allocation based on quotas.	Market prices coexist with administered prices (e.g., regulated utilities).
Typical strengths	High allocative efficiency, innovation, consumer choice.	Rapid mobilisation of resources, capacity for egalitarian goals.	Balance of efficiency and equity; ability to correct market failures.
Typical weaknesses	Externalities, inequality, information asymmetry.	Information & incentive problems, bureaucratic rigidity, shortages.	Government failure, policy distortion, administrative complexity.
Illustrative sectors	Consumer electronics, apparel, services.	Heavy industry, defence, centrally planned agriculture (historical).	Healthcare, education, transport (public) + private retail, finance.
Typical policy tools	Taxation, subsidies, competition law.	Production quotas, price controls, central budgeting.	Regulation, public ownership, welfare transfers, targeted subsidies.

Linkages to Other Syllabus Sections

The concepts in this lesson underpin several other AS‑Level topics:

• AS 3.1‑3.3 – Government micro‑economic intervention: how taxes, subsidies and regulation modify the market allocation mechanism.
• AS 4.1‑4.6 – Market failure: externalities, public goods and information asymmetry are discussed as weaknesses of the market allocation.
• AS 5.1‑5.4 – Macro‑economic policy: the role of fiscal and monetary policy in influencing aggregate demand and resource utilisation.
• AS 7 – Theory of the firm and consumer behaviour: the profit‑maximisation and utility‑maximisation ideas introduced here are expanded in Topic 7.

Suggested Diagram

Assessment Questions

1. Explain how the price mechanism allocates resources in a market economy. Use a diagram to support your answer, and comment on what happens when the market is in disequilibrium.
2. Discuss two major problems that planners face in a command economy, giving real‑world examples (e.g., the Soviet Union’s steel‑car‑truck allocation or contemporary North Korea).
3. Evaluate the statement: “Mixed economies achieve the best balance between efficiency and equity.” In your answer, refer to both market failures and government failures.