Market Economy Vs. Planned Economy- Understanding The Key Differences

The Chinese growth story has caught the attention of millions over the years. However, many enquire about the role of China’s 1978 transition from planned to market economy in its growth story1.
Historically, several countries continue shifting from planned to market economy and vice versa. Understanding these patterns is incomplete without comprehending the key difference between the two economic approaches.

Business thrives on the resources of a society. The comprehension of what is a market economy, the features of market economy and the distinctions between a planned and capitalist economy are integral for any business or profession since it defines the system of resource allocation in different economies. 
The objective of this blog is to analyse a market and a planned economy to highlight their relative impact on businesses and economic growth of the country.

What Is A Market Economy?

The economic system that determines commodity prices and production aspects through market forces of demand and supply is called a market economy. It is also known as a free market economy or a capitalist economy.

Under a free market economy, sellers are free to sell the products they want and at prices that suit them. Resource allocation is done by the economic agents privately, without any government control.

Take a look at the elements that come along in this economic system.

• Private Ownership: The ownership of most resources and businesses is in private hands. It gives individuals and organisations freedom of action regarding production and consumption decisions.
• Competition: The market economy depends upon competition between businesses to attract customers, drive innovation, and create higher-quality products. It also promotes more affordable pricing structures.
• Price Determination: Various demand and supply forces determine the prices. Buyers and sellers interact within their marketplace to establish prices for goods and services.
• Minimised Government Interference: A market economy emphasises minimal government involvement in economic affairs. The government's role revolves around upholding property rights, maintaining law and order, and providing public goods and services.

Advantages And Disadvantages Of A Market Economy

Benefits of a capitalist economy :

1. Consumers get a wide range of choices at competitive rates. Thus, the standard of living is high.

2. Producers have control over the production line and can maximise their profits.
3. Healthy competition among producers enhances efficiency and product quality.
4. The continuous need for product differentiation caused by market competition promotes innovation.

Disadvantages of A free market economy :
1. Producers can indulge in malpractices to maximise profits.
2. Consumers became vulnerable to exploitation through exorbitant prices.
3. A capitalist economy causes income and wealth inequality.
4. Resources can get concentrated in the hands of a select few individuals.

What Is A Planned Economy?

The economic system which determines economic aspects like price, production, distribution and investment through government plans is called a planned economy.

Under a planned economy, sellers sell the products at prices predefined by the government. Resource allocation is done through the plans. The objective is to focus on overall growth and development of the economy at large rather than focusing on a private individual.

Here are some characteristics of the planned economy.

• Central Planning: Production, distribution, and pricing decisions based on predefined goals and targets established by the government or central authorities.
• State Ownership: Under a planned economy model, the government owns most resources and businesses, directly controlling economic activities.
• Price Control: The government sets prices based on assessing the value and importance of products and services provided to it by businesses or producers. E.g., the government's minimum support price for staples like wheat grains.
• Extensive Government Intervention: A planned economy necessitates extensive government involvement. The government oversees every aspect of economic life, e.g. production levels, resource allocation, distribution, etc.

Advantages And Disadvantages Of A Planned Economy

Benefits of a capitalist economy :
1. Producers cannot indulge in malpractices because the government determines production.
2. Consumers are protected from exorbitant prices.
3. A planned economy aims for the equitable distribution of income and wealth.
4. Resources are also distributed equitably across different sections of the economy.

Disadvantages of a free market economy :
1. Consumers do not have freedom of choice.
2. Producers cannot maximise their profits.
3. Lack of competition among producers might adversely impact efficiency and product quality.
4. The sellers do not aim for product differentiation, resulting in a lack of innovation.

Key Differences Between Market And Planned Economies

The table below shows how a planned economy differs from a free market economy. The distinction between the two will not only strengthen the concept of each but also deliver keen insights into the causes that lead to a country’s transition from planned to market economy. 

The distinction is necessary to further understand how different systems perform resource allocation differently.

Impact Of Market And Planned Economy On Common Man

An economic system's influence extends far into people's daily lives. Listed below are the different ways in which each affects the lives of ordinary citizens.

• Freedom Of Choice
  Under a capitalist economy, individuals enjoy picking from a variety of available goods and services. Corporations can enter or exit markets freely based on demand. This empowers companies and helps achieve individual objectives.
  However, in a planned economy, the government determines which commodities and services are produced and how they are dispersed. This limits customer alternatives while diminishing market diversity and innovation.
• Incentivisation And Rewards
  The market economy gives individuals incentives and rewards for hard work and productivity. Entrepreneurs know the reward of taking risks and innovating. This system motivates individuals to hone their talents for success in the market.
  A planned economy involves governments controlling wages and rewards according to predefined criteria. It leads to decreased motivation among individuals, meaning they may not work harder or take on additional responsibilities.
• Social Equality
  Planned economies often prioritise social equality and redistribution of wealth. Government is central in providing equal access to resources and services such as education, healthcare, and housing. This helps eliminate income disparity while guaranteeing all citizens an adequate standard of living.
  The market economies emphasise individual initiative and personal responsibility more heavily. Although this system may lead to greater income disparity, it gives individuals better chances to reach new levels of success through hard work and innovation.

Market economies offer dynamic investment opportunities where supply and demand dictate returns. Diversify your portfolio with fixed-income options that provide stability and competitive yields.

Impact On Investors And Businesses

The impacts of a planned and a market economic model on investors and businesses ave a sharp contrast. The contrast becomes more evident when an economy transforms from one model to another.

The Indian economy is a unique example that can provide a deep insight into this contrast as it moves towards a mixed economic system, incorporating the features of both planned and market economies.

The Transformation Of The Indian Economy

Post-independence, the architects of the Indian economy realised the importance of private and public collaboration2. Therefore, they chose to slowly transform India into a mixed economy.

Although India stuck to 5-Year plans, the Industrial Policy of 1948 and the second five-year plan solidified their stance. However, due to the lack of capital with private individuals, the transformation was sluggish.

The status of the mixed economy was revitalised after the 1991 liberalisation. The following are the key takeaways.
Foreign brands like Pizzahut entered the Indian market and Indian businesses started innovating to compete.
Before 1991, the FDI was low. However, post-1991, it rose to USD 74 million3.
The consumers found access to a more diverse choice of products, increasing the standard of living.

The keen insights from the journey of countries like India can help categorise the most prominent distinctions between the two economic systems. The parameters discussed below can help understand the impact of each economic system on businesses and investments.

1. Stock market
In the case of planned economies, the stock market generally does not exist due to government control and ownership of economic entities. If a stock market exists, it will be under rigid government control and sensitive to only government decisions.

The features of the market economy uphold that it functions based on the demand and supply forces. Therefore, the stock market will be free from government control, exposing it to fluctuations based on the market environment.

The stock market under a planned economy will be more stable than a free market economy due to the lack of external influence. However, the return will also be more muted than in a capitalist economy.
2. Regulations
The business in a planned economy functions under complete government control. They produce and distribute at rates and quantities determined by the government. This minimises market competition, which reduces competition and contributes to a lack of choices and predatory business practices.

In a free market economy, producers produce and distribute at rates based on the existing market demand and supply, resulting in rampant competition. Customers have more options as a result, but they are also more vulnerable to deceptive corporate tactics.
3. Startup growth
A free market economy fosters entrepreneurship, resulting in a rise in startups. Planned economies don’t foster entrepreneurship. The growth of the startup ecosystem increases the employment and income levels of the economy. It also aids innovation and helps in improving the quality of product choices available to the consumers.

The Future: Are Hybrid Models the Answer?

A mixed economy refers to a hybrid of a planned and capitalist economy. In the modern world, absolute economic models have become a rarity, and countries have opted for a mixed economy that gives the best of both worlds.

While the government sets border economic targets and focuses on vigilance, the private sector navigates a particular business unit. In such a setup, consumers enjoy the benefits of choices and efficiency whilst the government ensures their protection from malpractices.

Case Study: How the Soviet Union Transformed from Planned to Mixed Economy?

The example of the Soviet Union as a planned economy is widely discussed. However, its transformation to a mixed economy is also very iconic. Popularly referred to as “shock therapy”, its transformation is a market with rapid liberalisation and privatisation3.

The transformation occurred after the collapse of the Soviet Union when the common people were exposed to the disadvantages of a planned economy. 

1. Since all businesses were owned by the government and oligarchs, they would close down suddenly without any notice during the economic turmoil. This further caused loss of income and employment.
2. The supply of desired products often diminished, and people had no access to commodities that they needed. There were no alternative private sources.

Currently, Russia is considered a mixed economy. It has both private and state-owned businesses.

The initial years after the transformation were marked with falling GDP, hyperinflation and poverty.  However, irrespective of the ongoing war and sanctions, Russia’s GDP grew by 3.8% in 20244. The transformation to a mixed economy helped in the following ways.
Foreign investment rose.
By the mid-2000s, Russia’s GDP started recovering.
The energy sector, especially oil and natural gas, dominated the growth5.

Conclusion

Every economic system strives to attain economic growth and development. However, their perspective and methodologies differ. While a capitalistic system believes that improving individual income and standard of living will automatically lead to economic growth, a planned economy looks at overall growth that is expected to percolate down to the individuals. 
Both systems have their unique advantages and disadvantages. Therefore, economies today strive to create a blend between the two models, resulting in the rise of hybrid or mixed economies. Visit Grip Invest to stay informed on market concepts and trends and benefit from changing market dynamics that affect your wealth-creation journey.

Frequently Asked Questions On Market Vs Planned Economy

1. What is the difference between a market and a planned economy?

A Market economy refers to economic systems where market forces of demand and supply determine production, distribution, and pricing decisions for commodities. However, a planned economy is an economic system in which the government controls the production, distribution, and pricing of commodities. A market economy promotes competition and efficiency among businesses while giving sufficient choice to customers.

2. Why do most economies adopt a mixed model?

Absolute economic models are becoming rare in the modern world, and nations are choosing hybrid economies that combine the best features of each. Companies operate inside a certain business unit, while the government establishes border economic aims and emphasizes monitoring. Customers profit from efficiency and choice in such a system, while the government protects them from unethical behavior.

3. What is an example of a planned economy?

The Soviet Union is a historical example of a planned economy, sometimes known as a command economy, in which the government regulated every facet of production and distribution, including pricing, output quotas, and important industries to promote social welfare and industrial progress. The objective is to ensure that resources gravitate to commodities a society needs rather than what it wants. Their transition from planned to market economy has not been opted for yet.

4. Is India a planned economy?

The Indian economy realized the value of both public and private cooperation after independence. The Industrial Policy of 1948 and the second five-year plan strengthened India's position, even though it continued to follow five-year plans. However, the shift was slow because private persons lacked the necessary funds.

References
1. CATO Institute, accessed from: https://rb.gy/ywfj7o

2. History Of Indian Economy, accessed from: https://cgijeddah.gov.in/web_files/267622636-History-of-Indian-Economy.pdf

3. Earth Columbia, accessed from: https://www.earth.columbia.edu/sitefiles/file/about/director/documents/SMF7.pdf

4. Statista, accessed from: https://shorturl.at/eN5DD

5. Carnegie Russia Eurasia Center, accessed from: https://shorturl.at/7lfM3

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