1a) The basic economic problem is one of scarcity of productive resources . Explain how resources are allocated between competing uses in a market economy . (10)
Scarcity refers to a limited number of resources such as workers, machines, factories, raw materials .
A market economy also known as a free market is one where decisions are made through the market mechanism. The forces of demand and supply, without any government interference, determine how resources are allocated. What to produce is decided upon by the level of profitability for a particular product. Buyers cast their spending votes in the market place.How production should be organized is equally determined by what is most profitable. Firms are encouraged through the market mechanism to adopt the most efficient methods of production. For whom production should take place, production is allocated to those who can afford to pay. Consumers with no money cannot afford to by anything.
There are mainly four factors of production . Land , Labour , Capital and Enterprise .
Demand is the quantity that consumers are willing to buy at a given price. For example, a consumer may be willing to purchase 30 bags of potato chips in the next year if the price is $1 per bag, and may be willing to purchase only 10 bags if the price is $2 per bag.The main determinants of the quantity one is willing to purchase will typically be the price of the good, one’s level of income, personal tastes, the price of substitute goods, and the price of complementary goods .
There are normal and inferior goods . Normal goods is when income rises the demand for the product will also rise . As income rises the demand curve for a normal good will shift to the right . An increase in income may cause a small shift to the right in the demand curve for salt but a larger increase in the demand for cinema tickets .
If a product is considered to be inferior , then the demand for the product will fall as income rises and the consumer starts to buy higher priced substitutes in place of the inferior good . Examples of inferior goods are cheap wine or own brand supermarket detergents . As income rises , the demand curve for the inferior good will shift to the left . When income gets to a certain level the consumer will be buying only the higher priced goods and the demand for the inferior good will become 0 . Thus the demand , curve will disappear.
If products are substitutes for one another , then a change in the price of one of the products will lead to a change in the demand for the other product . For example , if there is a fall in the price of a chicken in an economy then there will be an increase in the quantity demanded of chicken and a fall in the demand for beef . Which is a substitute.
Complements are products that are often purchased together , such as printer and ink cartridges . If products are complements to each other , then a change in the price of one of the products will lead to a change in the demand for the other product . For example if there is a fall in the price of Dvd players in an economy , then there will be an increase in the quantity demanded of Dvd players and an increase in the demand for Dvds , which are a complement . This will lead to a movement along the demand curve for Dvd players and a shift to the right of the demand curve for Dvds .
Supply is the quantity that producers are willing to sell at a given price. For example, the chip manufacturer may be willing to produce 1 million bags of chips if the price is $1 and substantially more if the market price is $2.
In general, demand and supplys theory claims that where goods are traded in a market at a price where consumers demand more goods than businesses are prepared to supply, this shortage will tend to increase the price of the goods. Those consumers that are prepared to pay more will bid up the market price.Conversely, prices will tend to fall when the quantity supplied exceeds the quantity demanded. This price-quantity adjustment mechanism causes the market to approach an equilibrium point, a point at which there is no longer any impetus to change. This theoretical point of stability is defined as the point where producers are prepared to sell exactly the same quantity of goods as the consumers want to buy.