How does the economy work and what do we do about it? Now that it is struggling, more people are getting interested in its mechanisms. It is a complex system to which different tools can be applied which can help, hurt or have no impact over it. Depending on the tools being applied to a specific economy (local, regional, state, even world), nowadays it is divided into two types – free market economy and planning economy. Both of them have their advantages and disadvantages but the former has already been proven to be better than the latter.
In a free market economy, it is mainly the people who make decisions both as consumers and suppliers. The government’s role is to create regulations which prevent businesses from misinforming – or failing to inform – them about their product. Its other pivotal roles are to prevent businesses from colluding (agreeing not to compete and/or charging the same price – it is illegal in the United States) and protect their intellectual property.
As a result of these regulations, consumers are aware of what they are buying. They know the ingredients of the food, cigarettes and so on that they buy at the local gocery store as well as its, and other products’, dangers and risks. For example, there are warning labels in bold on every pack of cigarettes informing us about their deadly risks – on some of them, there is even a phone number that we can call in search of a help to quit smoking. Judging by the smokers’ strong addiction to tobacco and their unawareness of its adverse impacts, these warning labels make sense but it also depends on the insight of applying the labeling policy, as we can see from the results in this study, but that’s another matter.
Everything else outside the government regulations in a free market economy is based on the supply and demand theory. In other words, the higher the supply, the lower and price – and the higher the demand, the higher the price. The two are interdependent. To put it even better, it’s about how much money people are willing to pay for a product and whether there is a supplier of the product to offer it to them at that price. All that makes some markets very profitable and expand while others may end up recessing to a point where they even disappear. That’s why capitalism is so great – because as long as there is demand for a product, there is supply.
Caution!!! Caution!!! Caution!!! As much as capitalist economists have a better understanding about the economy than socialist economists, they speculate that in a capitalist economy everybody wins. Their point is that you buy what you want and you get satisfaction by having it and using it, whereas the supplier is satisfied by your giving him the money for the product. The point that they make is a very good one but consumers should think more abstractly about it.
For example, having a breakfast at Starbucks shows class and therefore raises our self-confidence, not to mention that we don’t even have to prepare ourselves our breakfast. However, the more often we do have a breakfast at Starbucks, the bigger the hole in our pocket becomes.
Regardless of whether we are willing to pay that price for breakfast over a certain period of time, we should ask ourselves whether we would be better off both financially and socially by spending less money on breakfast through preparing ourselves one – and spend the money that we are expected to save on going to a disco or buying something to our beloved ones or whatever else you can think of. It’s called trade-off – if you spend $10 dollars on something, you have $10 less to spend on other things.
What about the planning economy?
Planning economy is one where the government (and in some cases labor unions, too) has control over the economy beyond the regulations mentioned above. In a planning economy, the market is not free – the government is in control of it by possessing it or enacting legislation that imposes price ceilings which means making it illegal to sell a product for a higher price than the one mentioned in the specific legislation.
Such kind of an economy has already been proven to be a disaster to the countries that implement it. At first sight, everybody should be satisfied because a lot of the services are for free – among them education and health care, as was the case with the Eastern Bloc and its allies – the funds for the performance of which comes from taxes and other revenues to the government such as investments, tourism and exports.
However, oftentimes there is not enough money as revenue to cover all the costs, which compels the government to print more money which leads to inflation of the national (or regional) currency. Such a policy has been typical of the Central and Eastern Europe in times when left-wing governments were in the executive branch after 1989. As a result of that, people’s savings start to drain which leads them to exchange their money in local currency for a foreign more stable one, provided that they can do it.
In a planning economy, there is also lack of creativity and working mood because the salaries are fixed. If Doctor A has examined 500 patients for the past month, and Doctor B has examined twice as much over the same period of time, both of them are given the same monthly salary.
This situation discourages Doctor B from putting efforts to further develop his or her skills, as it gives him or her no satisfaction in the form of money, or rest, or anything else besides having helped more people. As noble as altruism seems to us, it quickly fades away when Doctor B realizes how Doctor A is not that occupied and receives the same salary: as if Doctor B works for a cheaper price even though his or her services are most likely worth more.
These are among the whole lot of reasons why capitalism beat communism.