The theory behind what is a command economy can be understood using the example of the car manufacturing company in which two completely different plans were implemented, one that produced cars in a country where it cost more to build cars, and another that produced cars at a lower cost in a local economy. Both firms then invested their profits into marketing the cars to consumers in their country. Obviously both firms would gain from this situation. However, the workers of the first company did not benefit because their pay didn’t cover the difference in the prices of the products in the local economy, while the workers of the second firm profited because they received a raise to match the prices of the cars produced in their country.
A command economy, also called a command economy, is a form of coordinated economic system in which the allocation of resources, production, investment and distribution of goods takes place based on individual market-based plans, i.e., prices set by producers in response to consumer demand. A command economy can use decentralized, central, participative or central-level forms of planning. The theory behind what is a free market economy states that in a free market, prices are determined through competition among potential suppliers of a product. A company that offers a better price than its competitors will obtain a mass of buyers, while a company that offers the same price but at a much lower rate will not be able to secure a market share and therefore will fail.
The problem arises in what is a command economy when the decisions of the centrally planned economies result in less than optimal plans for distribution. Inefficiency, over-production and mal-distribution are the result. This occurs because the producers of a given product do not have adequate information or alternative markets to find out how to maximize profitability. The result is an inefficient allocation of resources. Incentive problem occurs when there is no sufficient incentive to increase efficiency.
There are two types of economies – flexible and rigid. A flexible economy can be described as one in which the means of wealth production are left to the consumers. In a rigid economy, the production of goods and services is directed by the central planners. Under the name of coordination, the central planners try to ensure that the distribution of goods and services makes sense and is effective in terms of maximizing the overall output of the economy.
A firm can be thought of as being in either a flexible or rigid economy. In a flexible economy, entrepreneurial activity is allowed and free, resulting in the creation of surplus production. This results in a dynamic economic calculation between demand and supply of resources. A firm in a rigid economy, on the other hand, may resort to investment in order to maintain or increase the rate of investment necessary to meet demand.
A central planner is the person who controls the distribution of resources in an economy. The planning process is normally performed through a board of directors at the highest level of the firm. However, some firms go through the central planning process by having appointed managers who actually make decisions for the company. The managers often believe that they are exercising control over the firm, since they are the ones who actually make the important decisions concerning strategic issues. Firms that function through a central board of directors are called command economies.
A command economy functions through the enforcement of productive efficiency. The firm is not able to maximize its potential for productivity if it does not have a firm structure that is based on effective allocation of resources. If demand is not in equilibrium, there will be an inefficient allocation of resources. The result will be lower output and higher costs. These results, in turn, will affect output, prices, employment and technology.
There is another key feature of a command economy. This is the ability of the firm to conduct business efficiently. In such a system, the firm can be both centrally and locally controlled by the central authority. If there are problems within a firm that are causing inefficient allocation of resources, the central authority may solve those problems by ordering production of goods in the form of what is called demand goods. For instance, if an entire factory is not producing enough demand goods, it can be ordered by the central authority to produce what is known as demand collateralized stock.
Wanda Rich has been the Editor-in-Chief of Global Banking & Finance Review since 2011, playing a pivotal role in shaping the publication’s content and direction. Under her leadership, the magazine has expanded its global reach and established itself as a trusted source of information and analysis across various financial sectors. She is known for conducting exclusive interviews with industry leaders and oversees the Global Banking & Finance Awards, which recognize innovation and leadership in finance. In addition to Global Banking & Finance Review, Wanda also serves as editor for numerous other platforms, including Asset Digest, Biz Dispatch, Blockchain Tribune, Business Express, Brands Journal, Companies Digest, Economy Standard, Entrepreneur Tribune, Finance Digest, Fintech Herald, Global Islamic Finance Magazine, International Releases, Online World News, Luxury Adviser, Palmbay Herald, Startup Observer, Technology Dispatch, Trading Herald, and Wealth Tribune.