Step ➊ : Define 'market economy and mixed economy' in the introduction. (Knowledge and understanding)


All societies are faced with the problem of scarcity, consequently, resources have to be allocated in the most efficient way. The free market economy and the mixed economy will allocate resources in different ways. In a free-market economy, there is no government intervention at all. All decisions are taken by individuals and firms. In a mixed economy, there is a combination of market forces and central planning


Step ➋ : Explain how resources in a market economy and a mixed economy are allocated in different ways.


➤ 2.1. In a free market, resources are allocated through the price mechanism. In contrast, the mixed economy involves both private and public sectors in the process of resource allocation.

In a free market, the price mechanism determines the production, utilization of resources, and pricing. 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 perform a signalling function, this means that they adjust to demonstrate where resources are required, and where they are not. Shortages result in prices rising. Surpluses result in prices falling. The profit motive and enterprise have a big role to play in the free market. In order to remain competitive and maximise profit, firms will try to utilise resources in the most efficient way possible to reduce costs. An important point to note is that the government has a very restricted part to play in a market economy.

By contrast in a mixed economy, both the free market and government participation is required in the allocation of resources by combining the best of both worlds. Decisions on most important economic issues involve some form of planning (by private as well as public enterprises) and interaction between government, businesses and labour through the market mechanism. Private ownership of productive resources operates alongside public ownership in many mixed economies.

➤ 2.2 In a market economy, merit goods will be under-produced and demerit goods will be overproduced. In a mixed economy, governments will adopt policies such as taxes, subsidies and information campaigns to ensure these goods are supplied correctly.

It is often argued that the market is unable to allocate resources efficiently due to market failures. For example, there tends to be overconsumption and overproduction of demerit goods. A demerit good is a product that is worse for the individual consumer than the individual realises. Examples are alcohol, cigarettes and various drugs. There is also an under consumption and underproduction of merit goods. A merit good is defined as a good that is better for a person than the person who may consume the good realises. Examples are education and healthcare.

In mixed market economies, the government may control the pattern of production and consumption of merit goods and demerit goods, by the use of legislation (e.g. making it illegal to produce unsafe demerit goods), by taxes and subsidies or by nationalisation. In many sectors, resources are allocated by a combination of markets and panning, such as healthcare and, which have both public and private provision.

➤ 2.3. In a market economy, public goods cannot be provided, whereas, in a mixed economy, public goods will be provided by the government

The free market fails to provide public goods such as defence or street lightning. This is because goods are non-excludable and non-rival. Non-excludable means that it is costly or impossible for one user to exclude others from using a good, and this gives rise to the free-rider problem. Non-rival means that the consumption by one consumer does not restrict consumption by other consumers. Examples include lighthouse and defence.

In contrast, mixed economies may have a distinct public sector, where resources are allocated mainly by the government, such as defence, police, and fire services.


Step ➌ : Conclude


To conclude, in a free-market economy the free market allocates resources according to the price mechanism, however, the market economy may fail to allocate resources efficiently due to externalities. There might be a need for government intervention. In the mixed economy, there is a combination of market forces and central planning.


♕ Marking scheme


Up to 4 marks for knowledge and understanding and application of how resources are allocated in a free market economy.

• Resources are allocated through the price mechanism (1 mark)
• Elaboration in terms of features such as supply and demand, consumer sovereignty, enterprise and the profit motive (Up to 3 marks).
Up to 4 marks for knowledge and understanding and application of how resources are allocated in a mixed economy.
• Resources are allocated through the price mechanism and the government (1 mark)
• Elaboration in terms of the provision of public and merit goods, intervention in markets such as indirect taxes on demerit goods and so on (Up to 3 marks).