Centrally Planned Economy

Definition

A Centrally Planned Economy, also known as a command economy, is an economic system in which the state or government makes all key decisions related to the production and distribution of goods and services. It determines what to produce, how to produce it, and who will receive it. This is in contrast to a market economy which relies on market forces to guide production and distribution decisions.

Phonetic

The phonetics of “Centrally Planned Economy” are: Centrally – /ˈsɛntrəli/Planned – /plænd/Economy – /ɪˈkɑːnəmi/

Key Takeaways

1. Complete control by the government: In a centrally planned economy, the government gets to make all the essential decisions about production, distribution, and consumption. This includes deciding what is produced, how it is produced and for whom it is produced.
2. Lack of Consumer Choice: Because the government controls the production of goods and services, consumers have fewer choices in a centrally planned economy. There is limited variety of goods available, and consumers may have to wait for a long time for certain commodities.
3. Focus on collective welfare: The focus of a centrally planned economy is more on societal or collective welfare rather than individual preferences. The government aims to distribute resources evenly among the population, which could potentially help to reduce economic inequalities.

Importance

The term “Centrally Planned Economy” is important in business and finance because it refers to an economic system in which the state or government makes all decisions about the production and distribution of goods and services. This includes decisions about what products are produced, how they are produced, and who receives them. This contrasts with a free market economy, where these decisions are largely made by individual consumers and businesses. A centrally planned economy can ensure that resources are allocated and used in a manner that serves a broader societal goal, however, it can also lead to inefficiency and lack of innovation. Understanding this term is crucial to comprehend different economic systems and principles, contributing to better strategic decision-making in global business environments.

Explanation

The primary purpose of a Centrally Planned Economy is to enable the government to directly control and regulate all major sectors of the economy and distribute resources according to the overall goals of the state. In such an economic system, the state is in charge of setting the production levels and prices of goods and services, determining distribution methods, as well as centralizing the decision-making process. This is thought to minimize economic inequality and leverage finite resources efficiently; thereby ensuring all the citizens achieve an equitable standard of living. By controlling what is produced, when, and at what price, these economies aim to eliminate economic fluctuations and inefficiencies. Additionally, a Centrally Planned Economy is used to guide the country’s economic activities towards the national goals rather than individual or business related profit. Here, the market forces of supply and demand are often disregarded as the central authority decides what needs to be produced based on their perception of the citizens’ needs. This system can be beneficial, specifically in times of crisis, like wars or natural disasters, when a rapid and comprehensive response is required to redirect the economy’s resources. However, it often lacks the dynamism and innovation associated with market economies, as individual entrepreneurial behaviour is not incentivized.

Examples

1. China: While China has shifted toward a mixed market economy with elements of capitalism in the past decades, historically, it was one of the most famous examples of a centrally planned economy. From 1949 to 1978, the Chinese government controlled all production decisions and resource allocation. 2. The Soviet Union: The Soviet Union operated as a centrally planned economy from 1922 until it dissolved in 1991. The government had control over decisions regarding investment, production, allocation and consumption within the country. 3. North Korea: North Korea represents one of the most comprehensive current examples of a centrally planned economy. The state controls all production, investment and allocation decisions and directly sets production goals, control prices, and allocate resources.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Command Economy
• Public Ownership
• Economic Planning
• Price Fixation
• Quota System

Sources for More Information

• Investopedia
• The Business Professor
• Wikipedia
• Corporate Finance Institute