Topic 2 | Revision Materials

The allocation of resources: how the market works; market failure

Candidates should be able to:

describe the allocation of resources in market and mixed economic systems; describe the terms primary, secondary and serivce (tertiary) sector in an economy
demonstrate the principle of equilibrium price and analyse simple market situations with changes in demand and supply
describe the causes of changes in demand and supply conditions and analyse such changes to show effects in the market
define price elasticity of demand and supply and perform simple calculations
demonstrate the usefulness of price elasticity in particular situations such as revenue changes, consumer expenditure
evaluate the merits of the market system
describe the concept of market failure and explain the reasons for its occurrence
define private and social costs and benefits and discuss conflicts of interest in relation to these costs and benefits in the short-term and long-term through studies of the following issues:
- conserving resources versus using resources
- public expenditure versus private expenditure.

What is an Economic System?

Because of the fact that there is scarcity of resources and unlimited wants, it is always a problem to allocate resources in an efficient manner. We are constantly facing three basic questions. These are:

What to produce?
How to produce?
For whom do we produce?

Every community or country must choose and develop its own way of solving these problems. The way a country decides what to produce, how to produce and for whom to produce is called it Economic System.
The three Economic Systems existing are:

Market Economic system
Planned Economic System
Mixed Economic System

Note:

There are no PURE command economies
There are no PURE market economies
Instead there is a continuum of different characteristics

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Planned Economy

In a planned economy, the factors of production are owned and managed by the government. Thus the Government decides what to produce, how much to produce and for whom to produce.

Features:

All resources are owned and managed by the government.
There is no Consumer or producer sovereignty.
The market forces are not allowed to set the price of the goods and services.
Profit in not the main objective, instead the government aims to provide goods and services to everybody.
Government decides what to produce, how much to produce and for whom to produce.

Advantages

Prices are kept under control and thus everybody can afford to consume goods and services.
There is less inequality of wealth.
There is no duplication as the allocation of resources is centrally planned.
Low level of unemployment as the government aims to provide employment to everybody.
Elimination of waste resulting from competition between firms.

Disadvantages

Consumers cannot choose and only those goods and services are produced which are decided by the government.
Lack of profit motive may lead to firms being inefficient.
Lot of time and money is wasted in communicating instructions from the government to the firms.

Examples of Planned economies

North Korea
Cuba
Turkmenistan
Myanmar
Belarus
Laos
Libya
Iran

Market Economic System

This economic system relics on the marker forces of demand and supply to allocate resources. The private sector decides on the fundamental questions of what, how and for whom production should rake place. The marker economic system is also known as the free market system or the capitalist economy.

Features of the marker system include the following:

• No government interference in economic activities - resources are owned by private economic agents who are free to allocate them without interference from the government.

• Resources are allocated on the basis of price - a high price encourages more supply whereas a low price encourages consumer spending. Resources are sold to those who have the willingness and ability to pay.

• Financial incentives allocate scarce resources - for example, agricultural land is used for harvesting crops with the greatest financial return, whilst unprofitable products arc no longer produced.

• Competition creates choice and opportunities for firms and private individuals. Consumers can thus benefit from a variety of innovative products, at compctith'C prices and of high quality.

Adva ntages of the market system

The marker system has the following benefits:

• Efficiency - Competition helps to ensure that private individuals and firms pay attention to what customers want.

• Freedom of choice - Individuals can choose which goods and services to purchase and which career to pursue, without being restricted by government regulations.

• Incentives - The profit motive for firms and for individuals to earn unlimited wealth creates incentives to work hard. This helps to boost economic growth and living standards in the country.

Disadvantages of the market system

• Environmental issues - There are negative consequences of economic prosperity under the marker system, such as resource depletion, pollution, and climate change.

• Income and wealth inequalities - In a marker system, the rich have far more choice and economic freedom. Production is geared to meet the needs and wants of those with plenty of money, thus basic services for the poorer members of society may be neglected.

• Social hardship - The absence of government control means the provision of public goods such as street lighting, public roads and national defence may not be provided.

Mixed Economy

A mixed economy is an economic system that incorporates aspects of more than one economic system. This usually means an economy that contains both privately-owned and state-owned enterprises or that combines elements of capitalism and socialism, or a mix of market economy and planned economy characteristics. This system overcomes the disadvantages of both the market and planned economic systems.

Features

Resources are owned both by the government as well as private individuals. i.e. co-existence of both the public sector and the private sector.
Market forces prevail but are closely monitored by the government.

Advantages

Producers and consumers have the sovereignty to choose what to produce and what to consume but production and consumption of harmful goods and services may be stopped by the government.
The social cost of business activities may be reduced by carrying out cost-benefit analysis by the government.
As compared to the Market economy, a mixed economy may have less income inequality due to the role played by the government.
Monopolies may be existing but under close supervision of the government.