THE TECHNICAL UNIVERSITY OF KENYA (TUK)

FACULTY OF ENGINEERING SCIENCES AND TECHNOLOGY

DEPARTMENT OF AEROSPACE & AVIATION ENGINEERING

ELEMENTS OF ECONOMICS
EMAQ 1281
ASSIGNMENT

LECTURER: MR. JOSHUA

KELVIN NYONGESA
EMAQ/01511/2017
BENG AERONAUTICAL ENGINEERING.
ASSIGNMENT ONE.
QUESTION: Compare the free market system and centrally planned economic system highlighting two
advantages and two disadvantages of each.
A Free Market is an economic system based on supply and demand with little or no government control.
In a free market, a majority of companies and properties are owned by individuals or entities in the
private sector instead of the state. Free markets are characterized by a spontaneous and decentralized
order of arrangements through which individuals make economic decisions.
A centrally planned economy or a command economy is one where the price and allocation of
resources, goods and services is determined by the government rather than autonomous agents as it is
in a free market economy
Unlike the free market economy in which businesses decide what they will produce, in centrally planned
economy the government makes the economic decisions.
Characteristics of free market economic system.

i. Private ownership of resources: Free economies exist because a significant portion of resources
are owned by individuals or companies in the private sector and not a central government
agency. In this way, the owners exercise total control over the means of production, allocation,
and exchange of products. They also control the labor supply.
ii. Freedom of Choice: Owners are free to produce, sell, and purchase goods and services in a
competitive market. They only have two constraints. First is the price at which they are willing to
buy or sell. Second is the amount of capital they have.
iii. Motive of Self-Interest: Each economic agent attempts to do what is best for itself for example
firms will tend to maximize profits while consumers will ten to maximize their utilities.
iv. Competition: The force of competitive pressure keeps prices low. It also ensures that society
provides goods and services most efficiently. As soon as demand increases for a particular item,
prices rise thanks to the law of demand. Competitors see they can enhance their profit
by producing it, adding to supply. That lowers prices to a level where only the best
competitors remain.
v. System of Markets and Prices: A market economy relies on an efficient market in which to sell
goods and services. That's where all buyers and sellers have equal access to the same
information. Price changes are pure reflections of the laws of supply and demand.

Characteristics of a Centrally Planned Economic System

i. The government controls all aspects of the economic production. In other words, the
government decides what goods will be produced and how they will be produced
ii. The government decides how resources are distributed and used. For example, if the
government thinks we need more goods in a particular area, they will make that decision, not
the businesses in that area
iii. Prices usually set by price controls rather than market forces and the government determines
the final price for all goods and services
iv. The state is in a position where it must make these decisions for society to function
 Advantages of a free market system

i. Freedom to innovate: In a free market economy, business owners enjoy the freedom to come
up with new ideas based on the consumers’ needs. They can create new products and offer
new services at any time they want to. As such, entrepreneurs rarely rely on government
agencies to notify them of consumers’ needs. The entrepreneurs do their own research and
identify popular trends. The innovation among different private companies can lead to
competition as every company tries to improve on the features of its products to make them
better.

ii. Consumer Sovereignty: In a free market, producers are incentivized to produce what
consumers want at a reasonable and affordable price. In general, consumers have more choices
for what goods and services to purchase.

Disadvantages of tree market system

i. A free market economy has high level of competition hence lacks a system to care for those who
are at an inherent competitive disadvantage. That includes the elderly, children, and people
with mental or physical disabilities.
ii. Poor Quality-Since profit maximization is the biggest motivation for firms, they may try to
reduce their costs unethically. In many cases, the drive for profit maximization actually
incentivizes unethical behavior.

Advantages of a centrally planned economy.

i. Prices are kept under control in a centrally planned economy: Because supply and demand
does not enter into the equation for a centrally planned economy, the government can dictate
what the prices should be for everyone in society. That makes it much easier to set cost levels to
a place where the average consumer can afford to have the items that they require.

ii. There is not the same level of economic inequality in this system: Because the goal is to
ensure that everyone receives the same access to all of their needs, you will find that the
inequality of wealth in this system is considerably smaller than it is in free market systems.

Disadvantages of a centrally planned economic system.

1. There are high levels of inefficiency in a centrally planned economy.

Because there is no motive for profit due to the price-setting schemes of the state in a centrally
planned economy, there is no reason for the companies that produce goods to become more
efficient in their processes. That means it typically costs more to create inferior items compared
to privately-owned companies in a free market system or one that is mixed.
2. Most centrally planned economies restrict individual rights.
The goal of a centrally planned economy is to have everyone working toward a common goal
and vision that the government decides. People are not usually free to pursue their own
interests in this structure. Even when the state gives its permission to engage in non-traditional
activities, that right can be revoked at any time.

REFERENCES

1. “Routledge Dictionary of Economics" entry: centrally planned economy, published Routledge

Press, 2013. Edited by Donald Rutherford Online version accessed [August 17th, 2017].
2. Taylor J.B, Economics. Boston: Houghton Mifflin Company, 1995, pp. 25
3. Parkin . M and Bade. R Economics: Canada in the Global Environment. Toronto: Pearson, 2013.
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