• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Price mechanism allocates a country's resources efficiently. Do you agree?

Extracts from this document...

Introduction

´╗┐For all practical purposes, human wants may be regarded as unlimited. Resources are scarceand are capable of alternative uses. The existing supply of resources is inadequate and is onlyenough to produce only a small fraction of the goods and services people desire. This scarcityof resources gives rise to some economic problems. They are the problems of a. what to produce, b. how and how much to produce, and c. for whom to produce. In a free market economy, these decisions are made through the interaction of prices which isknown as the price mechanism. In a centrally planned economy these decisions are reachedby the planning authorities. The in-between is the mixed economy in which the pricemechanism and the planning authorities will come in. But collectively, no matter how thesedecisions are reached, they determine the economy's allocation of the scarce resources.To achieve the best use of a country's resources means that there should be optimumallocation of resources. A state is said to have reached its optimum level in the allocation ofresources when its limited factors of production are put to the most efficient use or whenthere is productive efficiency. There must also be consumer welfare in that the price of agood or service equals the marginal cost of its production (P = MC) as in perfect competition.By efficient use of factors of production or productive efficiency, we mean that more resources should be allocated to the production of those commodities which are more highlydemanded by the people so as to prevent unnecessary wastage. ...read more.

Middle

As a result, producers will be induced to produce the goods and services that are saleable and profitable. Therefore, the problem of what to produce is usually solved by the pattern of consumer's expenditure under the price mechanism. If the demand for a particular good increases, its price will rise because there is a shortage of the good in the market. This high price of the good serves as an incentive for producers to increase output in the expectation of higher profits. But as supply increases, price will eventually fall and producers will stop increasing the output of the good. In other words, the price will eventually be pushed back to the equilibrium. On the other hand, a fall in the demand for the good will bring about a fall in price because consumers now want less than what is available. This will indicate to the producers that less should be produced. As supply falls low enough, the price will eventually go up again. In addition, productive efficiency and resource prices also influence what and how much to produce. With the profit motives of the producers, they will select the lowest possible cost of production so that not more than necessary resources are used. Goods that can be produced most efficiently and sold cheaply will enjoy a relative large share of the market. Changes in the resource prices will change the production costs, demand and output of the good. ...read more.

Conclusion

Thus, the market forces of demand and supply do not take into account social costs which may exceed private costs. The price mechanism will only work smoothly on certain assumptions: when there is perfect competition with factor mobility and flexible prices. It is only with the perfect competition that we are able to have factor mobility and flexible prices. The monopoly power creates market imperfections by preventing enough resources from moving in response to the market signals of high profits. It also controls prices and prevents the market from having flexible prices. Sometimes, producers may not know the cheapest method of production and inefficiency prevails. The first condition of economic efficiency is that whatever output the firm selects must be produced at the lowest possible cost of producing that level of output. Otherwise more resources will be used for this output than are necessary. Prices of the goods must be equal to the marginal cost of producing it. In this way, consumer's welfare is maximised. Firms do not necessarily produce in response to consumers' demand but through advertising may induce demand. Advertising has two major aspects: it seeks to inform consumers of the available products and it seeks to influence consumers by altering their demand. The first aspect, informative advertising, plays an important part in the efficient operation of any free market system; the second aspect is one through which firms seek to control the market rather than to be controlled by it. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Macroeconomics essays

  1. Budget 2004-05 and Economic Analysis of Pakistan

    Against an annual average rate of 1.4 percent in 1990s, per capita income grew at an average rate of 13.9 percent per annum during the last two years (2002-04) and 12 percent during 2003-04. The per capita income in dollar terms increased from $526 in 1999-2000 to $652.

  2. Economics - House Prices.

    to pay more money and to compensate for this the equilibrium price will fall and therefore meaning people, even though interest rates have risen, price of houses has gone down meaning people will pay the same as they would have before.

  1. Governments set economic objectives - Discuss the relative importance of each of these objectives ...

    If economic agents are suffering from money illusion, the point would fall back to point B [the natural rate of unemployment], causing the economy to be in the same state as previously. However, if the economy does not suffer from money illusion, workers push for higher wages, leading to higher prices.

  2. Compare and contrast the various methods of dealing with the problem of monopoly.

    Fortunately, there are several remedies for monopoly. The first that I am going to discuss is: regulation. An excellent remedy for pure monopolies (where a single firm dominates 100% of a market) is regulation. Regulation involves the government appointing an independent body to monitor the activities of the firms.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work