Step ➊ : Define ‘planned economy’ and ‘free market economies’ in the introduction.

The economic system is the term is used to describe the means or allocative mechanism by which its people, businesses and government make choices regarding the allocation of scarce resources. Traditionally, economists have recognised three distinct types of economic system – these are the market economy, the planned economy and the mixed economy. It is often debated which one of these economic systems is more beneficial.


Step ➋ : Discuss how the free market allocates resources through the price mechanism

In a free market economy, decisions on how resources are to be allocated are usually taken by the price mechanism. The price mechanism determines the production, utilization of resources, and pricing. This means that the forces of demand and supply determine what goods and services will be produced, how they will be produced and for whom will they be produced.  Prices act to indicate the likely market value of particular resources. For example, a commodity in short supply but that has a high demand attached to it will have a high price. Alternatively, one that has a high supply and low demand will have a much lower price attached to it. Prices and the self-interest of people and businesses therefore act as a guide to the decisions that have to be taken. For example, if consumers decide they want more of a good, demand will exceed supply and prices will rise. This is a signal to suppliers to expand production to meet the higher demand. Most importantly, the government has a very restricted part to play in a market economy.

The advantages of a market economy include increased efficiency, productivity, and innovation. The profit motive encourages producers to be more efficient. The lack of government intervention leads to competition and increased efficiency. With the existence of competition, a business tends to do whatever is necessary to lower its costs and achieve a higher number of sales and increase its profit.  Innovation is also promoted because it provides a competitive edge.