David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 1 Economics and the economy
Prices guide your decision to buy a beefburger, McDonald's decision to sell beefburgers, and the student's
decision to take the job. Society allocates resources - meat, buildings and labour - into beefburger
production through the price system. If people hated beefburgers, McDonald's sales revenue would not
cover its cost. Society would devote no resources to beefburger production. People's desire to eat beefburgers
guides resources into beefburger production.
However, when cattle contract BSE, consumers shun beefburgers in favour of bacon sandwiches, and the
price of BLTs rises. As the fast-food industry scrambles to get enough pork, the price of pigs rises but the
price of beef falls. Adjustments in prices encourage society to reallocate land from beef to pig farming. At
the height of the British beef crisis, caused by fears about 'mad cow' disease, pork prices rose 2 per cent but
beef prices fell. Quite an incentive to reallocate!
In a command economy a
government planning office
decides what will be produced,
how it will be produced, and
for whom it will be produced.
Detailed instructions are then
issued to households, firms and
workers.
The command economy
How would resources be allocated if markets did not exist? Such planning is very
complicated. There is no complete command economy where all allocation
decisions are undertaken in this way. However, in many countries, for example
China, Cuba and those formerly in the Soviet bloc, there was a large measure of
central direction and planning. The state owned factories and land, and made the
most important decisions about what people should consume, how goods should
be produced, and how people should work.
This is a huge task. Imagine that you had to run by command the city or town in which you live. Think of
the food, clothing and housing allocation decisions you would have to make. How would you decide who
should get what and the process by which goods are made and services delivered? These decisions are
being made every day, mainly by the allocative mechanism of markets and prices.
Poor Marx for central planners
During the Cold War, economists used to argue about the relative merits of capitalism and
communism. But the Soviet bloc, falling increasingly behind the living standards of the West,
abandoned Marxist central planning after 1990 and began transition to a market economy. By 2003 fans of
Chelsea Football Club were celebrating their new owner Roman Abramovich, who had made his fortune in
the market economy, initially as an oil trader and then as chairman of one of Russia's leading oil companies.
The Berlin Wall fell because the Soviet bloc had fallen far behind market economies in the West. Key difficulties
that had emerged were:
• Information overload Planners could not keep track of the details of economic activity. Machinery rusted
because nobody came to install it after delivery, crops rotted because storage and distribution were not
co-ordinated.
• Bad incentives Complete job security undermined work incentives. Factory managers ordered excess raw
materials to ensure they got materials again the next year. Since planners could monitor quantity more
easily than quality, firms met output targets by skimping on quality. Without environmental standards,
firms polluted at will. Central planning led to low-quality goods and an environmental disaster.
• Insufficient competition Planners believed big was beautiful. One tractor factory served the Soviets from
Latvia in the west to Vladivostok in the east. But large scale deprived planners of information from
competing firms, making it hard to assess efficiency. Managers got away with inefficiency. Similarly,
without electoral competition, it was impossible to sack governments making economic mistakes.
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