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Economics: Centrally Planned Economies


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About this Lesson

  • Type: Video Tutorial
  • Length: 10:57
  • Media: Video/mp4
  • Use: Watch Online & Download
  • Access Period: Unrestricted
  • Download: MP4 (iPod compatible)
  • Size: 117 MB
  • Posted: 03/29/2010

This lesson is part of the following series:

Economics: Full Course (269 lessons, $198.00)
Economics: International Focus (25 lessons, $43.56)
Economics: Transition Economies (4 lessons, $7.92)

This video lesson on economics looks at centrally planned economies. Taught by Professor Tomlinson, this lesson was selected from a broader, comprehensive course, Economics. This course and others are available from Thinkwell, Inc. The full course can be found at The full course covers economic thinking, markets, consumer choice, household behavior, production, costs, perfect competition, market models, resource markets, market failures, market outcomes, macroeconomics, macroeconomic measurements, economic fluctuations, unemployment, inflation, the aggregate expenditures model, banking, spending, saving, investing, aggregate demand and aggregate supply model, monetary policy, fiscal policy, productivity and growth, and international examples.

Steven Tomlinson teaches economics at the Acton School of Business in Austin, Texas. He graduated with highest honors from the University of Oklahoma and earned a Ph.D. in economics at Stanford University. Prof. Tomlinson's academic awards include the prestigious Texas Excellence Teaching Award given by the University of Texas Alumni Association and being named "Outstanding Core Faculty in the MBA Program" several times. He has developed several instructional guides and computerized educational programs for economics.

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We have been discussing the macro economy as if it were the sum of impersonal forces. That is individuals each acting in their own self-interest, supply and demand, loanable funds, goods and other things. And, prices result from the interaction of supply and demand without anybody really being in charge. That is the economy has a kind of self-regulating character. Now, this was Adam Smith's idea back in 1776 when he wrote the Wealth of Nations. It was his contention that there was no need for central planning because the self-interest in choices of buyers and sellers would lead to prices that brought about the right amount of the right kinds of goods and services.
Now, there is another tradition of economic thinking that is associated with Karl Marx. It was Marx's view that the outcome in the economy could be improved upon by central planning. That if you left things to the impersonal forces of the market you got an outcome that was inhuman and inefficient. And, therefore, that some kind of central planning could improve upon the impersonal forces of the market.
Well, let's see, nowadays, how an economist thinks about the continuum between a completely laissez-faire free market and a completely directed central market. That is central planning that has some kind of director at its head. Let's start with what every economy has to deal with. An assortment of individuals each of whom has their own particular wants and needs. People want hamburgers, people want vacations, people want medical care, and also, these individuals represent different kinds of skills. There are people who are good at carpentry, people who are good at solving math problems, people who are good at childcare, people who are good at building houses. And, in addition to the human capital or skills that people carry around in their heads there is all kinds of physical capital, machines, factories and the like. So, here you have a collection of individuals with their tools. Each of whom has their own particular want and each of whom has their own particular abilities.
Now, how do these people cooperate in such a way as to specialize and trade and create wealth? After all, if you are left to your own devices and have to be self-sufficient you are going to live at a subsistence level and be relatively poor. On the other hand, if you cooperate with others and specialize and trade, wealth grows. So, how do we make that happen? Well, think for a moment about the amount of information that has to be transferred in the process of creating an outcome where people are specialized in trading. First of all, people have to communicate their wants. So, each of these individuals has to make their wants known in some way to all of the others. An expression of wants or a registering of their preferences that information has to somehow be collected. Also, what has to be collected is information about people's relative abilities at different kinds of tasks. Maybe I am relatively good at writing stories and you are relatively good at baking bread and so forth. But, how are we going to find out whose skills are relatively good? How are we going to find out who can bake bread with the lowest opportunity cost? And, whose going to have comparative advantage in teaching?
Now, once all of this information has been expressed it has to be somehow collated, some were organized, sorted through and then a plan has to be arrived at. What does each person in this economy going to do? How is each particular unit of capital going to be employed? So, once some kind of master plan has been formulated then communication has to go in the other direction. Everybody has got to be told what their role is in the master plan, how they are supposed to act, and what actions they are supposed to carry out. So, you are supposed to become a waiter, and you're supposed to become a chemist, and you're supposed to become a butler, and you're supposed to become an accountant and this plan is going to make the pie the biggest for our society. Create the biggest chunk of wealth that we can then distribute among us.
Now, the question is, how are we going to get this done? Every economy has to solve this problem by collecting information, creating a plan, and then coordinating the individual agent that is telling everyone what their role is in the plan. And then motivating them to carry out their role in the plan. No matter what kind of economy you've got its got to solve these problems.
Now, the idea in Marxist economics is that you get a better outcome with some kind of direction at the top of this pyramid. That is, we are going to put a central planner here and his or her role is to collect the information from all of the individuals in this economy and find out what they want. Find out what their skills are. Collect information about the tools and capital that are available to them. And formulate a master plan, and you can see that he is really thinking.
So, what he is going to do then is communicate this information back to the individuals involved. He is going to tell them what their role is that he is going to coordinate their actions. And, he is going to motivate them to carry these actions out. Now, this is a pretty good scheme. I mean, this is the way most families run. This is the way clubs run. Maybe this is the way things run for you at work. But you can see immediately there is quite a bit of cost associated with this system. First of all, this guy has to come up with some scheme for getting all of these people to reveal truthfully their preferences and their abilities.
Now, how do you get people to tell the truth? The first thing I think when somebody asks me what I'm good at is, what do they want and how can I work this question to my advantage? I may not always be inclined, even though I am a basically truthful person, to tell someone information that I think is not their business. Right now many of us are filling out census forms and mailing them back and we're suspicious about what is going to be done with this information. Imagine if the government was asking you, what are you good at, what do you want, this is potentially a problem. But, suppose we can solve that problem. Suppose we can get all of these individuals to truthfully communicate their abilities and their desires. And, suppose they know themselves well enough to be able to express that on paper or in some kind of multiple choice form.
Well, then this guy has to figure out first of all what is the master plan. Wow, how are you going to figure out how to put all these pieces of the puzzle together and come up with a job for everybody? And, once you do that and tell everybody what their job is, how are you going to get them to carry it out? Maybe you are going to use threats. Maybe you are going to use coercion. Maybe you are going to use bribery. What is it? Maybe you are going to use encouraging coaching, fatherly talk. Who knows? But, still there is a lot of problems to be solved here, the collection of information, the formulation of the plan, and, the motivation of the individuals to play their role.
Plus, there's another problem, because once we have a face on this economy, everyone is going to start to appeal to this guy as if he were Santa Claus, right? Because you are going to call him up and say, I really don't like being a waiter any more, I want to be a coal miner or an artist and in the meantime, I want to be paid twice as much. Well, if there is somebody to appeal to you are going to find yourself spending some of your time in what we call influence activities. That is, trying to get this guy to change his mind rather then you working harder to make your money the old fashioned way.
So, you can see then that all kinds of problems arise when you take economic activity and personalize it rather than making it purely commercial. Because now, I mean it is kind of human nature to want to give responsibility to somebody else for something, we can give him the responsibility. And, imagine sometimes how we treat our parents whenever we don't get what we want. Well, that's what starts to happen and productive activity in the economy gets diverted in this kind of influence activity.
This is why economists are suspicious of central planning. It is not so much that central planning can't, in many cases, improve over the free market outcome. Remember the case of people standing up at the football game, you just need somebody with a bullhorn on the 50-yard line saying, sit down, already you are not accomplishing anything. However, if we let more and more of economic activity be directed by one person, we get the problem of miscommunication, the difficulty of collecting and collating information, and the problem of a face, which then leads to influence activities.
Now, free market economists, on the other hand, believe that these two roles, coordination and motivation, can be better served by the impersonal price mechanism. Everybody looks at the prices. The prices that you can get for providing different services and you let the price be your guide. I find out that I can make a lot more money as a teacher than I can as an accountant so I can figure my human capital according to that employment. And, look what the price does? It coordinates. It tells me where to go. It tells me where I can make the most profit. And, it motivates me. Because, if I work hard I get bonuses, I get a salary, I get to keep my job and maybe get a raise. So, the price serves those two roles. It gives me information about where my resources are best employed. And, it gives me an incentive to work harder.
So, what happens then is all of these individuals by being willing to supply their abilities and demanding the products created by other people, interact through the impersonal forces of supply and demand. And, the prices that are set in equilibrium guide people into jobs where they are going to make the most money and be able to use their talent in ways that most give other people the things that they want.
Now, don't get me wrong, I'm not saying that either one of these extremes is a desirable outcome. Because, either one of these extremes has problems associated with it. Whenever you try to do everything impersonally then you have got externalities. You get monopoly. You get problems with information whenever people don't reveal accurately the quality of the products that they are trading. And, you get all kinds of wealth effects. I mean, the market doesn't redistribute income. So, the market has its own set of problems. But, as far as coordination and motivation the reason that free market economists are fans of the market is because it accomplishes these tasks. When it does with the least amount of influence activity, the least amount of corruption and the most reliable transfer of information people are going to accurately communicate their abilities and their desires in the market because they are immediately rewarded for doing so.
So, when we discuss centrally planned economies we are talking about some kind of real world economy that is closer to the extreme of central planning then what many of us are used to who live in the United States. But, the truth is, if you work for a big corporation you are part of a centrally planned economy. If you work for a university you are part of a centrally planned economy. And you can notice by the way business works, by the way bureaucracy works, by the frustrations sometimes that people feel when they feel like things have become personal rather than commercial. That there are costs associated with the benefits of having one person's directional intelligence over the process of resource allocation.
So, we are going to continue this discussion by talking about some real world instances of centrally planned economies. And, you will see these ideas coming up as we look at the stories.
International Focus
Transition Economies
Centrally Planned Economies Page [3 of 3]

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