Chapter 2: The allocation of resources
The basic economic problem creates 3 questions:
● What to produce?
● How to produce?
● Whom to produce?
Market system
When producer and consumer engage in an exchange.
- Decisions made by private sector organization
*consumers maximize satisfaction while firms maximize profit.
Advantage of market system:
● Variety of goods are produced
● Firms attentive to changes in wants and spending
● Develop new products and use most efficient production method
● No tax
Disadvantage of market system:
● Firm produce only profitable goods and supply
● Firm only produce for those who are able to pay
● Resources will be employed if it is profitable to do so
● Harmful goods may be produced if profitable
● Some consumers and producers ignore harmful effect of Their activities
● Firm restrict competition and charge high prices
Price mechanism
Refers to the system where the forces of demand and supply determine the prices of goods and
services.
*consumer demand increase (production becomes profitable) - > price increase and producer
output increase
- Entrepreneur allocate resources to most profitable uses
Market failure
, The market fails to produce goods and services that are worthwhile or when the decisions of
producers or consumers result in wasteful harmful activities. Therefore result in misallocation
of resources.
How can the government correct market failure?
● Direct provision of goods and services (invest in new school and hospitals)
● Make regulations (Eg. Price controls)
● Indirect taxes : reduce consumption of undesirable goods and services
● Subsidies to firms : reduce production cost and to encourage consumption for desirable
products
Consequence of market economy:
● Public goods (Eg. Street light) will not be provided
● Too few merit goods (Eg. Healthcare) will be supplied and consumed
● Harmful goods are over-supplied and consumed
● Firms may exploit their consumers and employees
Mixed economy system
Combines the government planning and ownership of resources with the use of the free market
economic system to determine the allocation of resources in the economy.
Advantages of mixed economy System:
● Provide useful and essential goods and services
● Provide goods and services for people in need
● Employ people in public sector organization
● Outlaw harmful goods and services
● Outlaw business practices that restricts competition and mislead consumers
● Government ownership and control of scarce resources
● Regulate the actions of private firms
Issues with government intervention :
● High tax on people and firm can distort market price signals and reduce work incentives
The basic economic problem creates 3 questions:
● What to produce?
● How to produce?
● Whom to produce?
Market system
When producer and consumer engage in an exchange.
- Decisions made by private sector organization
*consumers maximize satisfaction while firms maximize profit.
Advantage of market system:
● Variety of goods are produced
● Firms attentive to changes in wants and spending
● Develop new products and use most efficient production method
● No tax
Disadvantage of market system:
● Firm produce only profitable goods and supply
● Firm only produce for those who are able to pay
● Resources will be employed if it is profitable to do so
● Harmful goods may be produced if profitable
● Some consumers and producers ignore harmful effect of Their activities
● Firm restrict competition and charge high prices
Price mechanism
Refers to the system where the forces of demand and supply determine the prices of goods and
services.
*consumer demand increase (production becomes profitable) - > price increase and producer
output increase
- Entrepreneur allocate resources to most profitable uses
Market failure
, The market fails to produce goods and services that are worthwhile or when the decisions of
producers or consumers result in wasteful harmful activities. Therefore result in misallocation
of resources.
How can the government correct market failure?
● Direct provision of goods and services (invest in new school and hospitals)
● Make regulations (Eg. Price controls)
● Indirect taxes : reduce consumption of undesirable goods and services
● Subsidies to firms : reduce production cost and to encourage consumption for desirable
products
Consequence of market economy:
● Public goods (Eg. Street light) will not be provided
● Too few merit goods (Eg. Healthcare) will be supplied and consumed
● Harmful goods are over-supplied and consumed
● Firms may exploit their consumers and employees
Mixed economy system
Combines the government planning and ownership of resources with the use of the free market
economic system to determine the allocation of resources in the economy.
Advantages of mixed economy System:
● Provide useful and essential goods and services
● Provide goods and services for people in need
● Employ people in public sector organization
● Outlaw harmful goods and services
● Outlaw business practices that restricts competition and mislead consumers
● Government ownership and control of scarce resources
● Regulate the actions of private firms
Issues with government intervention :
● High tax on people and firm can distort market price signals and reduce work incentives
