Economic Systems for Resource Allocation
Decisions about resource allocation are necessary because we live in a world of scarcity. A review of the ideas listed at Key Points 1.1 and 1.2 should remind you of how central this basic premise is to the study of any branch of economics. To take a surreal example, when you open your front door in the early morning there are not millions of bottles of milk covering the neighbour’s lawn; nor is there no milk. There is just enough bottled milk to meet the demand: say, the two pints your neighbour ordered. What this chapter seeks to explain is how this finely tuned allocation of resources can occur, given the multitude of construction, manufacturing and service resources that simultaneously need to be allocated. The problems of resource allocation are solved by the economic system at work in a nation. In the case of construction, resource allocation has been strongly influenced by the public sector. What is produced, how it is produced and for whom can be determined by central government – and it was frequently – but governments across Europe now prefer to use a market system to answer the what, how and for whom questions. In general terms, therefore, it is possible to envisage two model systems. Each economic model brings together producers and consumers in different ways and each needs to be appreciated in order to understand how the universal questions about resource allocation are resolved.
Economic Systems: Two Extremes
The problem of resource allocation is universal as every nation has to tackle the issue of determining what, how and for whom goods and services will be produced. In Figure 2.1 we begin our presentation of the economic systems of the world by introducing two extremes: the free market model and the centrally planned model (along with two exemplar nations).
Figure 2.1 A spectrum of economic systems
On the extreme right-hand side of the diagram is the free market model, and on the extreme left-hand side, the centrally planned model. Cuba is a country whose system closely resembles the centrally planned model. At the other extreme is the USA, which comes close to the free market model. In between are the mixed economies of the remaining nations of the world.
Centrally Planned Model
Free Market Model
Effective Use of Resources
FREE MARKET MODEL
The free market system is typified by limited government involvement in the economy, coupled with private ownership of the means of production. Individuals pursue their own self-interest without government constraints: the system is decentralised. An important feature of this system is free enterprise. This exists when private individuals are allowed to obtain resources, to organise those resources and to sell the resulting product in any way they choose. Neither the government nor other producers can put up obstacles or restrictions to block those in business from seeking profit by purchasing inputs and selling outputs. Additionally, all members of the economy are free to choose what to do. Workers may enter any line of work for which they are qualified and consumers may buy the goods and services that they feel are best for them. The ultimate voter in a free market, capitalist system is the consumer, who votes with pounds and decides which product ‘candidates’ will survive. Economists refer to this as consumer sovereignty as the final purchaser of products and services determines what is produced – and, therefore, ‘rules’ the market. Another central feature of the free market economy is the price mechanism. Prices are used to signal the value of individual resources, acting as a kind of guidepost which resource owners (producers and consumers) refer to when they
Figure 2.2 The price mechanism at work
Price changes co-ordinate the decision-making processes of consumers and producers. When supply exceeds demand, the price of a product will need to fall for the market to...