Aug 25 2007

The magic of markets – missing in Zimbabwe!

Command vs. Market economics in Zimbabwe:
Mugabe’s decree on prices puts Zimbabwe economy in a tailspin – International Herald Tribune

And a blog post commenting on the news:Empty shelves in Zimbabwe
Managing Globalization » Economics 101 in Zimbabwe

Our first unit in AP Economics (and Friday’s lecture) examined the differences between command economies and market economies. One of the main points of yesterday’s lecture was that markets work because they result in an efficient allocation of resources towards the right products, using least-cost production methods, and putting those products in the hands of the people whose resources command the highest value in the resource market. If too much of one good is being produced and not enough of another, the “invisible hand” of the market will reallocate resources from the over-produced product to the under-produced product.

One of the reasons command economies fail is that central planners who attempt to control output and price, even when their intentions are to help consumers by assuring enough stuff is produced and available at an affordable price, are in essence acting against a basic economic law: that of supply and demand. In Zimbabwe, where inflation has reached nearly 10,000 percent (that means a candy bar that costs $1 today will cost $100 in a year!!) the president recently attempted to place price controls on all products by forcing merchants to slash their prices in half. The result? Food has vanished from the shelves of markets in Zimbabwe:

Essentials like bread, sugar and cornmeal, staples of every Zimbabwean’s diet, have vanished, seized by mobs of bargain-hunters who denuded stores like locusts in wheat fields. Meat is nonexistent. Gasoline is nearly unobtainable. Hospital patients are dying for lack of basic medical supplies. Power blackouts and water cutoffs are endemic.

Manufacturing has slowed to a crawl, because few businesses can produce goods for less than their government-imposed sale prices. Raw materials are drying up because suppliers are being forced to sell to factories at a loss. Businesses are laying off workers or reducing their hours.

As our first AP unit “Basic Economic Concepts” winds down, this article and blog post seem timely to remind us of one of the core principles of Economics: the importance of prices and markets in allocating resources (land, labor, capital and entrepreneurship) towards producing the goods and services society most wants. Later in the year we’ll examine what happens when markets fail, which they often do; but at this point in the course it is important to understand that despite their failures and shortcomings, free markets rarely experience the chaos associated with command economies of the past, and even the present as the Zimbabwe example shows. In the words of Daniel Altman, the blogger linked above:

The Soviets, Chinese and some of their allies kept their tightly controlled economies going for quite a few decades, though not perhaps with unalloyed success (former backyard smelters in China will get the pun). Mugabe’s version hasn’t even lasted through a change of seasons. Now, there are still a few lingering arguments in academia and policy circles about the merits of command economies. But a poorly planned command economy – no one seems to want that. Can anything short of total collapse follow?

Any thoughts? Why did Mugabe’s attempt to help consumers by keeping prices low only make the problem worse? What does this say about markets versus planned economies? Discuss!

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

36 responses so far

36 Responses to “The magic of markets – missing in Zimbabwe!”

  1. kevinyehon 26 Aug 2007 at 1:08 pm

    It's very interesting how the curb on prices actually causes the food shortage to worsen. This is very similar to the situation china is facing now which we discussed in class. Since the planned economy has the power to forcibly keep prices down, producers no longer consider it profitable to produce equal amounts. This is what caused the emptying of the shelves leading to even greater inflation because the demand remains the same while the supply is diminished

  2. Charlie.Gaoon 26 Aug 2007 at 5:16 pm

    Yeah, I agree with Kevin. Mugabe's attempt to keep the prices low backfired because the producers cannot pay for the costs they needed to make the products in the first place which creates higher debts and the company will soon be near the brink of bankruptcy.

    This just goes to show u that planned economies don't work as effectively as market economies because the planned economy wastes its resources on things that aren't demanded as much by the public. Market economies are more effective in analyzing supply and demand and then producing things according to it.

  3. welkerjasonon 26 Aug 2007 at 5:55 pm

    Charlie, you're right about the role of supply and demand and how planned economies don't follow these basic laws, while markets do. Good comments!

  4. Angel Liuon 26 Aug 2007 at 6:33 pm

    Although it is against the principle of supply and demand to control price inflation, most governments would most likely force the price down to ease public burden. I think that countries with unstable economy, especially those switching from a command economy to a market economy, needs great assistant from stable economies. It should be stable economies' responsibility to help so we can build a stronger global economy, which benefits everyone. Underdevleoped countries start with a command market because it lacks technology and capital to function normally.

  5. emilyyehon 26 Aug 2007 at 6:55 pm

    I think the difference between Zimbabwe's command economy and that of the USSR is that Zimbabwe has a very evident issue with corruption. Whereas the communist government of the Soviet Union attempted to redistribute wealth amongst the people, it is obvious that in Zimbabwe there are the rich, and the poor. Those with political connections outright exploit these rights. There is no political sense of "equality" in this command system, which has shortened its lifespan.

  6. Elaine Lungon 26 Aug 2007 at 9:50 pm

    Mm, there does seem to be greater class disparity in Zimbabwe, but I don't know if it's to the extent that Emily says. Evidently, there's a middle class (who, as the article says, are being hit hardest) and even the rich – or at least the rich who don't have political connections – are being affected pretty badly (read: white business manager eating a peasant meal). All in all though, I'm nitpicking, because I essentially agree with what Emily's saying.

    And yes, the problem with Zimbabwe's command system (and really, all command systems) is that the question of what goods are actually needed is virtually disregarded as the only incentives are to fill predetermined (and often faulty) quotas and rise politically. This means, as seen in Zimbabwe, shortages of goods the people need and surpluses of that which they don't need.

  7. Chan Min Parkon 26 Aug 2007 at 10:34 pm

    This is exactly what we discussed in class last time, about China trying to keep the prices of the cup noodles down. Cup noodles, if China tries to keep the prices low, it will lead to bankruptcy of something else really bad. Due to scarcity, prices shouldn't be kept down. If wheat prices go up someday and the cup noodle companies need wheat to make cup noodles, their profit will decrease. At a point, it might happen that their ingredients add up to 10rmb to buy, but the cup noodles are kept as 3 rmb by the Chinese government, the cup noodle company is going bankrupt. Thus the increase of prices sometimes is not just because the companies feel like it, but is because they have their own profit to worry about.

  8. Kevin Chiuon 27 Aug 2007 at 3:37 pm

    This crisis of their economy is a prime example of why command-like economies collapse; the lack of freedom of choice in production and lack of consumer soverignty results in a surplus of goods being produced. For instance, since the price of the product is kept constant, the firms producing the product will not be able to maximize in profit; thus, the firms may not gain a high enough income to produce a sufficient amount of resources at a low price while maintaining their own firm.

  9. Margaret Liuon 27 Aug 2007 at 10:49 pm

    Been thinking. How do people who don't even know more than I do about economics come to power. You wonder what Carl (Karl?) Marx was thinking when he wrote Marxism or whatever it was that made communism such a big hit way back whenever. When has it EVER been successful? Are these people just so power hungry their willing to sacrifice the country they tried so hard to gain's economic stability/possible success? I mean, after China's sudden economic boost since its reforms to a freer market (MB says its total output has been doubling every 8 years), you'd think other communist countries would follow suit.

  10. Michael Chowon 27 Aug 2007 at 10:54 pm

    I believe that Mugabe's action was justifiable because after all he only did it under good intentions. If a country like the on in this article, Zimbabwe were to keep it's prices down to try and keep it affordable to the average person, the conflict of bankruptcy or limitations in profits in companies or organizations will cause a halt in production. By limiting the prices of everyday food necessities such as bread and meat the producers of such are not able to survive due to the overall and necessary inflation on products.

  11. welkerjasonon 27 Aug 2007 at 10:56 pm

    Good Questions Margaret! Maybe you should try reading Marx's "communist manifesto". Interestingly, while Adam Smith's "Wealth of Nations" was 900 pages long, Marx's manifesto was around 75 pages! Maybe that's why none of his ideas every really worked! He just didn't give them enough thought! And look at Smith, his capitalism is EVERYWHERE today! -HA!

  12. Calvin Luon 27 Aug 2007 at 10:59 pm

    It is hard for me to imagine situation like this where everything that satisfy the needs of the population all vanished. In my opinion, this trouble is caused by the command system in Zimbabwe and international trade. During the inflation, the currency of Zimbabwe depreciates dramatically in the international market. To cope with this, the companies had to increase the price of their product in order to gain profit. This result is hard for the consumers as their wages couldn’t keep up with the change.

    The government’s attempt to control the price may seem to follow the rule of “consumer sovereignty”, but they forgot that this rule is base on profit. Our economies do not follow this rule because the producers are bound to serve consumers no matter what, but because consumer’s demand is usually where profits come from. As the Zimbabwean government cuts down the price, these goods are no more profitable despite consumers demand. Why would anyone produce something that’s not profitable? As a result, these producers stop all their production in order to minimize output.

    This wouldn’t have happened if Zimbabwe was a closed economy as the government can control everything as will, even the currency. But because of international trade, the demand of the currency not only comes from Zimbabwe, but other countries as well.

  13. Mondon 27 Aug 2007 at 11:05 pm

    Even though Mugabe acted with good intentions, the results that he brought upon was devastating. I dislike the government controlled prices system, because it totally disregards the supply and demand principle. Ineffective prices results in inefficient use of supplies, which often result in wasting of the resources and the downfall of the economy. On the other hand the free market policy will ensure that nothing like this will happen, because they produce and price their products according to the supply and demand principle. The is more efficient in utilizing resources.

  14. jacqueszhangon 27 Aug 2007 at 11:06 pm

    Let's take an example. You are selling Product X. This product costs $30 to produce and can sell at $50, giving you a profit of $20 per unit sold. The government, however, says you can only sell it for $25, half-price. For every unit you produce and sell, you end up losing $5. You're better off not producing Product X, correct? That's exactly what happens in Zimbabwe's situation. In the end, the slashing of prices stops production of food and other goods because no profit is gained from selling these products.

  15. HowardJingon 28 Aug 2007 at 3:21 pm

    As a lot of other people have said, Mugabe made problems worse by forcing businesses to sell products at a loss, which resulted in people being able to buy twice as much stuff as they could have bought yesterday, while doing nothing to increase the production efficiency.

    I think that Mugabe might have helped if he got rid of money altogether and introduced some sort of complex rationing system where motivated workers are rewarded with increased rations (althoug this sounds kind of like money). But it really shows how much the market is like the environment, where dumb mistakes can totally screw up a country with unintentional consequences.

  16. Kristie Chungon 28 Aug 2007 at 8:10 pm

    As many of the people have already stated, the problem with command economies as evident from the Zimbabwe economy is that resources are being used in products that are less desired rather than those that the people actually want and need. Instead of producing dog biscuits, ketchup, toilet paper and other such luxury items that can no longer be afforded by the people, resources should be put into producing more flour, sugar, cooking oil, corn meal and other such necessities. However, with the command system, people are more focused on reaching production quotas rather than producing goods that would actually help the people. On the other hand, market economies would have allowed the people, not the government, to have the freedom of choice to produce goods as they see fit.

  17. robertwangon 28 Aug 2007 at 9:25 pm

    As everyone above pretty much fleshed out, yes, part of the reason is the flaw of the command economy in which the supply decreased (due to the failures of companies no longer profiting from each sale) whereas the demand for basic goods remained the same or increased for that matter.

    However, I'd also like to point to one quote in the article: "Essentials like bread, sugar and cornmeal, staples of every Zimbabwean’s diet, have vanished, seized by mobs of bargain-hunters who denuded stores like locusts in wheat fields." This is also a significant cause to Venezuela's problem. At the get-go, the wealthy in the nation could already afford these products, but when the government slashed prices, it simply made it easier for the wealthy to purchase the goods. Thus, as prices were low, the could buy in mass, which left little to none left for the poor in Venezuela, which was the original target of the government.

  18. Tim Chuon 28 Aug 2007 at 9:46 pm

    The problem with keeping prices low is that the producers will begin to lose money. While prices are inflating due to whatever reason, low resources etc., the government is keeping the price down. This results in a steady approach to bankruptcy for most of these companies. The government may be trying to help, but this is in fact only worsening the situation.

  19. Takaon 28 Aug 2007 at 9:51 pm

    I don't know what else to add for everyone pretty much hit the point about how Mugabe's price controls have showed yet another example of why command economies do not work.

    But in my belief this ties in with more political problems than economic. Someone mentioned earlier (forgot who and I don't want to go through all of the comments again) said that the political ties of the wealthy have left out the poor and results in corruption. With this strong focus on the wealthy, the poor cannot obtain the daily nessecities thus resulting in an economic crisis. Although the best cure for this is allowing trade from countries with strong, stable economies, it is not as easy as it seems.

    Africa in general have many unstable governments and economies. Also with zwimbabwe located more in the center and not near a coast, trade routes must go through other countries. However, neighboring countries have similar issues with zimbabwe, political and economic instability, civil unrest, corruption, and are not well developed. In order for Zwimbabwe to even maintain trade from the outside world, neighboring nations must do their part in fixing their internal problems. It will be a slow process for Africa as a whole to do such a thing thus resulting in this economic crisis.

  20. Christina Huon 28 Aug 2007 at 11:26 pm

    Although Magube's intentions were seemingly pure, his price cut failed miserably because of incentives. When a producer has no incentive to produce a certain good or service, he will not produce it anymore! In this case, production in Zimbabwe probably stopped because the manufacturers were not getting enough profit [incentive] for every unit. If Mugabe really wanted to decrease inflation, he should have started taking bills out of circulation (as the US gov. did in the early 1900s), instead of immediately cutting prices in half. Cutting prices may have worked as well, but only if they were decreased gradually, by a small percentage.

    This shows that the economy knows best, and prices are truly important because 1)they let producers know what produce more of, and 2)prices help money flow, which is vital nowadays since we no longer barter, and need to use money to purchase resources. If money is not flowing, then producers probably do not have enough of it to buy the resources they need for efficient production.

  21. Cassy Changon 28 Aug 2007 at 11:29 pm

    The problem with command economy is like transplanting an animal into a foreign environment. Central planners may have good intentions, but their actions are ignorant to the whole fundamental basis of economics. Supply and demand determine prices of products according to the agreed benefit of both the buyers and sellers. Cutting prices in half tips the balance, and buyers suddenly can afford to demand more than what can be supplied; therefore, the result is shortage of goods.

  22. Jo Loon 28 Aug 2007 at 11:30 pm

    The problem with a lot of the comman system countries is that they are always trying to get back at the West because of their history of imperialism. What Mugabe is trying to do by going against the West is something that many countries have tried to do in the past. A lot of these countries think they will succeed over the west but instead they fail miserably, usually with consequences that doom their own country. During the Cold War, the USSR leaders tried their hardest to build as much weapons as possible to one day defeat the West. They put so much time and resources into the military that the economy and the people were not moving forward. This doomed the country, and today Russia is still relatively weak. It seems ironic that the poorest nations are the ones trying to discredit the west and their systems.

  23. Jenny Kimon 29 Aug 2007 at 12:16 am

    I think this situation in Zimbabwe clearly shows an example of planned economy not being succesful. And such examples have been presented a number of times in history in places such as China and USSR. Although Mugabe's intention to improve their economy was good, it just does not work out because price of a product must be based on the supply and demand. The government that adopts command economy tries to regulate the whole flow of economy without regarding what the consumers want. And this is why command economy does not work.

  24. Jessica Chiangon 29 Aug 2007 at 1:16 am

    With an increased demand and a decreased supply, the system is thrown off balance and Zimbabwe is now in an even bigger crisis. Although Mugabe's intentions were good, he hurt the economy by cutting prices in half. As other people stated, the marginal cost of producing products might exceed the marginal benefit, and producers no longer produce products. Even if the producers DID benefit, they no longer want produce their products, as they profit less.

    Command economy doesn't work because the producers have no incentive or motivation to produce their products; all the want to do is to meet their quota (set by the government, of course) and to get their money. There is no competition, which frequently results in faulty products. Also, the government is not able to completely control the entire economy, and they make many mistakes regarding where to allocate resources. For example, they might "command" factories to produce 12 trucks and 3 bikes per year while the demand is only for bikes. On the other hand, the market economy works because it is based on consumer sovereignty and supply and demand; the businesses and entrepreneurs can change the amount they produce or what they produce based on what the public demands.

  25. timothysunon 29 Aug 2007 at 6:11 pm

    Jacques, you must be talking about a "price ceiling" (obviously there is a corresponding price floor). These are what I consider to be major flaws of "impure" market economies. What I mean by impure is that there is still a little bit of government intervention. This price floor prevents firms from selling the product at the desired price (usually at the equilibrium). This prevents a high profit (or any at all!) and is not beneficial to the producer. Since the product is not profitable, it would probably disappear from the market. This also hurts consumers, so therefore everyone is a loser in this situation.

    You think this inflation is bad?

    "The most severe known incident of inflation was in Hungary after the end of World War II at 4.19 × 10^16 percent per month (prices double every 15 hours)."

    Imagine Bill Gates not being able to afford our school tuition with that kind of inflation!

  26. Sharon Lion 29 Aug 2007 at 6:39 pm

    Like everyone has already noted, this price-halving catastrophe in Zimbabwe highlights a huge flaw in command economies: directing an economy with no room for flexibility to accomodate the costumers' constantly changing needs.

    This also brings us back to the basic economic problem: that peoples' needs are infinite while the resources to fulfill those needs are limited. In a command economy, having a single planner, in this case Mugabe, place a quota on what people need and what firms can produce is unrealistic since demands are bound to change.

    A market economy succeeds because firms decide what and how much of a product to produce in accordance to customers' preferences. This freedom of choice peoples' needs to be constantly fulfilled.

  27. Jessica Ngon 29 Aug 2007 at 8:46 pm

    I was very surprised by Mugabe's decision in cutting the prices in half. Although he acted on good intentions, he did not quite seem to have thought through his decision, and on the whole, it seems almost naive and ignorant. As leader of a nation, Mugabe should have at least considered the consequences of his decision, that obviously, firms will not produce anymore once they do not profit! They might even have lost money in this case, and still continuing to produce in which total revenue

  28. Jessica Ngon 29 Aug 2007 at 8:51 pm

    hmm i'm not sure why my comment is cut off in the middle.. but to continue…

    … in which total revenue

  29. Jessica Ngon 29 Aug 2007 at 8:54 pm

    apparently the "less than" sign cuts comments off. SORRY.. hahah to continue. which total revenue is less than total profit is in fact stupid in the view of economics.

    Command economic systems like Zimbabwe's tend to fall behind capitalist market economies as without competition, and having everything planned out, makes the command system quite inflexible, which in turn easily allows serious mistakes, like the case of Zimbabwe, to be made.

  30. Jeewon Ohon 30 Aug 2007 at 12:37 am

    This article clearly shows the problem of a command economy. Even though Mugabe was only trying to help the consumers by controlling the prices that would have increased due to inflation, it led to the emptying of shelves of markets in Zimbabwe. It seems like the lowering of prices is a good thing, but in reality, it is not. The producers pay for the costs needed to make the products, then sell the products at a higher price in order to make profit. However, in a command economy, the government has the power to keep the prices low, which causes the costs to make a product to exceed the price of the product. This leaves the producers with nothing, which leads to the ceasing of production.

  31. Richard T.on 30 Aug 2007 at 1:28 am

    The price control should not occur during an economy, even if the government is a influential external factors. The resources are scarce,and if the price of the products is controlled, then the economy would be losing money every second. The economy will decrease becuase they are not earning any profit. If so, the might as well just give out "free" supplies.

  32. Claire425on 30 Aug 2007 at 7:04 am

    As we discussed in class, since food is the necessiate product which we MUST purchase, the price control led to a devastating situation. It is surprising that the government, regardless of the situation that will happen later, cut the products in to half and made increasing debts which could even let to bankruptcy later. The producting factories, industries will become more and more harder to be controlled and more and more Zimbabweans will starve.

  33. Hansen Guon 31 Aug 2007 at 1:07 am

    The puzzle piece of supply and demand is missing in this jigsaw. Without this basic principle, the command economy is flawed in that it cannot accommodate change. Such a drastic slashing of prices has led to businesses producing on almost no profit margins and there is no incentive to do so. Perhaps indeed the next step would be Mugabe's threat to business to keep producing. However, even then, with the dollar vote of the consumer, the market demand will change, but the production will still be of low quality and the same.

  34. Dana Yeonon 31 Aug 2007 at 5:14 am

    The dilemma of command economies is clearly highlighted in this article. Even though everybody has already said why command economies are led to demise, I want to reflect on the reasons why command economies do not work once again. First of all, the problem stems from its roots as the central planning body does not know what the consumers really want. They make ideal plans about how everyone should get equal portions of goods, but yet, their illogical plans not only NOT lead to an "equal" society, but to a society where there is a lack of products. Furthermore, because the producers in command economies are more motivated in getting their "rewards" by producing X amount of products asked for them to produce, and because the "reward" is set, they do not have an incentive (in this case, profit) to work harder for. Now, going back to Mugabe's policies, I agree that he made a very naive decision that did not carry out well. My question is why countries employ command economies when it has been proven time and again that they do not work. Even China and the Soviet Union who endorsed the command economy the most gave up on it (China in 1987).

  35. jenniferchoion 31 Aug 2007 at 5:23 am

    This article clearly shows the problem of command economy. Maybe the intetion of Mugabe's attempt to help consumers by keeping prices low was good, but it actually created more disaster than ever. The prices of goods (Even thought inflation caused them to be absuredly high) in Zimbabwe are the costs that are need to produce certain goods, but the government, by cutting down the prices in half, made production itself almost impossible. As this case shows command economy is ineffective type of market system because many times the government acts too arbitrarily.

  36. kevinhuangon 07 Sep 2007 at 8:15 pm

    I agree with Jennifer because maybe the intention of Mugabe was to help consumers; however, unknowningly made things worse. This is one of the command economy's biggest problems: price. In a market economy, the price is set by whatever would be acceptable to consumers and what would also keep the businesses in business, but in a command economy, if the price is set by a central body, the balance of the economy could be upset, which is what has happened in Zimbabwe.