Why do some people believe that the market system is the best mechanism for allocating scarce resources and thereby encouraging a positive investment climate? Explain your answer There are three different types of ways of allocating scarce resources which are pure market economy, pure command economy and mixed economy. (Griffiths, Wall, 2008) Some people believe that the free market is the best mechanism for allocating scarce resources. A pure command economy is an economy in which the government makes all allocation decisions and answers all three questions of allocation A mixed economy is a mixture between markets and the government making decisions on allocating resources. (Griffiths, Wall) A pure market economy is markets that alone allocated the resources of land, labour and capital. The Government also have no role in resource allocation. A pure market economy also has price determination, thus bringing supply and demand into balance. (Griffiths, Wall, 2008) Advantages of a pure market economy is that buyers are free to buy what they like in whatever amount they wish, the biggest advantage that the free market has is the determination of price, determined by the demand and supply, the decision of what to produce and in what quantities is taken by the free market and is not determined by the state. (Griffiths, Wall, 2008) This is why it is believed to be the best way of allocating scarce resources.
Above is an example of how a free market can respond to changing market conditions. The increase in demand leads to higher price and encourages firms to supply more. This is what Adam Smith referred to as the ‘invisible hand of the market’ Adam Smith coined the phrase ‘the invisible hand’ which describes the natural force that guides free market capitalism through competition for scarce resources. According to Adam Smith, in a free market each participant will try to maximize self-interest, and the interaction of market participants, leading to exchange of...
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