A command economy is an economic system where a central authority, typically the government, makes all major decisions regarding production, distribution, and resource allocation. This structure replaces the decentralized mechanism of the market, where prices are determined by the interaction of supply and demand. Instead of reflecting scarcity or consumer preference, prices in this system are purely administrative tools used by the state to achieve predetermined political or social objectives. Understanding this non-market mechanism is essential to comprehending how resources are directed.
Defining the Command Economy and Price Function
The state controls the apparatus of production, including factories, land, and capital goods. Prices in this system do not serve as signals of scarcity or consumer willingness to pay, which is their primary role in a market economy. They function as accounting devices to help central authorities manage the flow of resources and track the performance of state-owned enterprises. Prices are therefore a function of policy directives, designed to support national priorities such as rapid industrialization or social equity. The government uses these administrative prices to direct inputs to priority sectors, ensuring that planned production targets are met.
The Role of Central Planning in Price Determination
The core mechanism for setting prices rests with a central planning entity, historically exemplified by bodies such as Gosplan in the former Soviet Union. This entity is tasked with formulating comprehensive, multi-year economic strategies, often known as Five-Year Plans, which set quantitative production goals for thousands of distinct goods. Prices for nearly every commodity are then set administratively as part of this planning cycle. The process is highly bureaucratic, involving a complex series of negotiations between the central planners, industrial ministries, and state enterprises. Prices are essentially decreed from the top down, a cumbersome method that lacks the real-time feedback inherent in market-driven systems.
How Input Costs and Production Targets Influence Pricing
Central planners attempt to calculate prices using a form of cost-plus methodology, even though a true economic cost is impossible to determine without market signals. This calculation involves estimating the costs of production, including labor, raw materials, energy, and transportation, often using fixed, historical values that do not account for current conditions or real-world scarcity. A mandated profit margin is then added to this calculated cost, with the resulting revenue usually flowing back to the state budget through mechanisms like the turnover tax. Prices are frequently manipulated to support macro-level production quotas; for example, the price of iron ore might be set artificially low to ensure the state steel industry can meet its output targets. This systematic use of non-economic prices means that the cost structure for one industry is often subsidized by another, making rational resource allocation nearly impossible.
Distinguishing Between Consumer and Producer Prices
Command economies commonly employ a stratified pricing system, distinguishing sharply between producer and consumer goods. Prices for intermediate goods, such as machinery, coal, and raw materials, are set to facilitate resource transfers between state enterprises and to direct capital investment toward priority sectors like heavy industry. These producer prices are often disconnected from final demand and serve as mere accounting entries within the planning bureaucracy. Conversely, prices for final consumer goods like bread, rent, and basic clothing are frequently subsidized and set artificially low. This stratification is a deliberate policy choice aimed at achieving social equity goals, maintaining a basic standard of living, and ensuring political stability.
The Economic Consequences of Centralized Pricing
When prices do not reflect true economic information about scarcity and demand, the resulting economic system is fraught with inefficiency and unintended outcomes. Setting prices too low, particularly for consumer goods, causes demand to consistently exceed supply, which leads to chronic shortages and long queues for basic necessities. Conversely, setting prices too high for certain products can result in unwanted surpluses, as consumers are unwilling or unable to purchase the goods. The lack of market competition and profit incentives also removes the impetus for quality control, often resulting in poorly made products that are undesirable to consumers. Ultimately, the vacuum created by official, non-functional prices is often filled by a parallel black market, where goods are traded at prices that reflect actual supply and demand, establishing a true, albeit illegal, market price outside of the state’s control.