Question 1.1: Resource Allocation
Economics for Business & Management Abstract In this section of the assignment we focus on the question: “Examine the arguments in favor of a free-market system of resource allocation”. (Negru, 2011) The arguments for and against a free-market system are not black and white, therefore they have been discussed among economists for hundreds of years and no solution or conclusion has been found yet. In this assignment we briefly discuss the basic concepts of a ‘Free-Market’ economy as well as the ‘Command-Market’ system and how our present economic structure relates to them with a final focus on resource allocation in a ‘Free-Market’ system. Introduction “A problem facing all consumers is that whilst our wants (desires) may be unlimited, our means (resources) to satisfy those wants are limited” (Griffiths and Wall, 2008). This basic theory of economics shows the main problem the market faces. It leads to the question of how to allocate scarce resources among a variety of products. The limitations can be shown in a ‘Production Possibility Frontier’ (PPF), where the limited amount of resources can be divided up between two products. Although it’s a good and easy method to identify boundaries and Figure 1: PPF
possibilities, other factors influencing the market have not been taken into consideration in this graph (Samuelson and Nordhaus, 2009). Free Market System On the basis of a free market system, firms (suppliers) and customers (demanders) are the only two parties involved in the market (Investopedia, n.a.). Figure 2 shows that the equilibrium point, where supply and demand intersects at a given price for a given quantity, is where producer and consumer meet (Griffiths and Wall, 2008). Adam Smith stated that; a free market is guided by an “invisible hand”, which balances itself out without government Figure 2: Demand & Supply
interference. Therefore the main belief of a pure market economy (=free market
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Question 1.1: Resource Allocation
economy) is that: “Markets alone are used to allocate scare resources of land, labour and capital” (Griffiths and Wall, 2008) while “Prices (determined on markets) act as ‘signals’ to producers and consumers, bringing supply and demand into balance (equilibrium)” (Griffiths and Wall, 2008). While the fundamental idea of a free market system emphasize the freedom of individuals to purchase and consume whatever they like, it splits the population into segments of rich and poor where the rich become richer while the poor become poorer (Economy Watch, 2010). Social Market System Karl Marx, a famous philosopher and socialist in the 19th century tried to avoid poverty and greediness by emphasizing an economic system (later called Marxism, a form of Command economy) where government ensured that every individual is equally treated by eliminating privatization of the market. Instead of believing in the market and self-regulation through the invisible hand, the government ‘plans’ production and the allocation of resources. This social thinking leads to a nationalization of resources such as capital, land, property and companies. Although many “mainstream economists” in the early twentieth century were pro-socialists, Ludwig von Mises and Friedrich Hayek tried to prove the errors associated with social economic systems (Scarlett, n.a). Mises stated in his book ‘Socialism’ that government planning causes a “lack of calculation” (Mises, 2009), referring to non-pursuing of maximizing profits and loss avoidance (Yeager, n.a.). and destroys incentives for innovation from individuals while Hayek claims: “This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals” (Brainyquote, n.a.). Today: Mixed Economy...