Assessment of the market economy system
Title: The market system is the best method of resource allocation. Governments should limit themselves to the protection of private property rights. Discuss
When people talk about free market economy, we usually associate it with capitalist economy system, which was an unacceptable form from Chinese viewpoint in the old days. However, in the modern world, market economy does play an important role in regulating actions in the trading market and many countries are running under the market economy system as well. In my opinion, market economy is the best method of resource allocation up to now, and it should be put into the dominant and decisive place in the economic system, government intervention mixed at the same time.
As economy is concerned with allocating the scarce resources to satisfy human beings' unlimited wants, the central problem is focused on problem of scarcity. So any economy system, whatever command economy or market economy, must be able to allocate resource as efficiently as possible. However, market economy, has an absolute advantage in both productive and allocative efficiency, compared with the former, because people can make rational choices according to the interaction of demand and supply which will have an impact on the price of the goods and services.
Free market economy is also known as "Laissez-Faire" economy, which means government will not give people assignment to accomplish and all the decisions made are based upon pure self-interests, which is the most efficient incentive for individuals. The incentive is the "invisible hand" of the market, as Adam Smith described. He argued, "Although economic actors pursued their own self interest, the result would be an allocation of resources in the economy which would be in the interests of society as a whole"(Anderton A. p.720). It turns the "vice" of selfishness into the "virtue" of serving the community.
Privatisation, first of all, is a notable feature in market economy, which is to transfer the assets from the public sector to private sector by deregulation. In this way, the firms has more freedom deciding what to produce, how to produce and to whom to produce according to demand and supply in the market. What is more, the future of a firm is closely associated with individuals because they own the asset of the firm. That is to say, individuals will benefit from the profit they make, and individuals will also damage if they make a loss. So privatisation give the society a competitive atmosphere where individuals will do what they can to make more benefit so that the market get the productive efficiency due to the incentives.
From the producers' point of view, they try to make more producer surplus (profit). I think there is a simplified mathematic formula representing producer surplus:
Producer surplus = (Price - Cost) * Quantity of Sale
In perfect competitive market, individuals have no power to control the price of the goods and services. So from the formula, be may find out that a producer can only determine the variable "cost". If a producer wants to use the same amount of input to get more output, the only way to think of is to innovate the procedure of ...
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From the producers' point of view, they try to make more producer surplus (profit). I think there is a simplified mathematic formula representing producer surplus:
Producer surplus = (Price - Cost) * Quantity of Sale
In perfect competitive market, individuals have no power to control the price of the goods and services. So from the formula, be may find out that a producer can only determine the variable "cost". If a producer wants to use the same amount of input to get more output, the only way to think of is to innovate the procedure of production, which is shown in figure 1. So innovation becomes important, just as what president Jiang Zemin says, "Innovation is the first produce force."
Figure 1
Besides privatisation, there is another characteristic of market economy system-specialization, which results in much higher productivity than self-sufficiency system. Different degree of specialization may occur between individuals, firms, religions or nations. When it happens between individuals, it is usually called "division of labour", which is the production of a certain kind of good or service done by a number of people who are responsible for different parts of the work. The seemingly separation of work, in fact, is co-operation of jobs, and division of labour indeed demonstrates what we called today-teamwork spirit. Adam Smith's pin production factory was a famous example showing the great productive efficiency when division of labour functioned. He explained the reasons of the great increase of the quantity of work as follows:
"First, to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labour, and enable on man to do the work of many."
Resource: Adam Smith the Wealth of Nations Book1 Ch1 pp.15
As we know, nowadays, division of labour occurs in almost all areas of market economy. For example, in schools, different teachers give different lessons, some staff are responsible for the management of the school, some are responsible for the library, some are responsible for the IT Center, some are responsible for the restaurant, etc. we cannot let people be self-sufficient, because it will lead to extremely low efficient, if they could do all the jobs.
Additionally, specialization also provides individual an opportunity to specialize in each activity where they have a comparative advantage so that the society as a whole will again get the increased efficiency. This is particularly common in trading. Take China for example, table 1 shows the total units of each type of production produced by the two parts of China over a certain periods of time:
Comparative advantage (units of output)
Light Industry
Heavy Industry
North China
00
40
South China
80
60
Table 1
From the table, we can see that South China has an absolute advantage in both light industry and heavy industry, however North China has a comparative advantage in the case of heavy industry. Thus North China should specialize in heavy industry production and trade its goods for light industry goods from the South, and the South should specialize in light industry and exchange for heavy industry goods from the North, because North China has a lower opportunity cost in heavy industry production, but the South does not. In doing so, the two parts of China get the maximized benefits from trading and specialization, and obviously, the nation becomes more productively efficient as a whole in consequence of specialization.
According to the advantages in a free market, government should limit its action to protect private property rights, in order to make the market perform fully in advantages to get maximized efficiency. However, as every coin has two sides, market economy system is not perfect, and it has its own disadvantages as well. For example:
* Imperfect competition: what I argued before is under the premise of perfect competition. However, in real life, problems will occur due to imperfect competition. One distinct example is monopoly. If a monopolist controls over the factor of production, for instance all the raw material, it can deny access to the new rivals. As there is only one firm in the area, it has a strong power to control the price of its product in the market. In other words the firm can determine the price, but not demand and supply. This will definitely cause supernormal profit, which will next lead to inefficiency.
* Externalities: the action of producers or consumers will at the same time have an impact on the society besides on buyers and sellers. The externalities can be either beneficial or bad to society. Taking a medicine firm who has negative externalities for instance, the firm may dump chemical waste directly into a river or pollute the air in order to cut down its product cost to maximize the profit. The firm will only think of what it owns-the profit, and it will think nothing of what he does not own-the river and the air, because self-interests determine his action in the market. Hence free market, in this situation, will fail in environmental protection.
To the contrary, if the goods have so greater marginal social benefits (MSB) than private benefits (MB), i.e. great positive externalities, shown in figure 2, there will be too limited individuals producing, for example, the infrastructures of a country. "Public goods will not be provided by a free market. The problem is that they have large external benefits relative to private benefits and without government intervention it would not be possible to prevent people having a free ride and thereby contributing to their cost of production."(Sloman J. p.212)
Facing these problems in a free market, government intervention is strongly needed for redistribution of resources, for correction of externalities, for regulations and laws. Taking taxation for example, government imposes a tax on that medical factory to equal the marginal pollution cost, thus it will internalize the externality it created into its cost, which is shown in figure 3. Also it will make the factory an incentive to reduce the pollution as much as possible, because it is the same as to reduce its cost. So the MSC curve shifts downwards to a new level and because of the tax, MC curve shifts upwards to meet MSC' where MC'=MSC'. Hence there will be a change to equal marginal private cost (MC) to marginal social cost (MSC), which results in social efficiency.
In conclusion, market economy system has absolute advantages in allocating limited resources. It automatically maximizes both the productive efficiency and allocative efficiency in ways of constantly minimizing the cost by the development of high technologies. In doing so, the world has made unconceivable wealth. At the same time government should also play its role in the market, wherever the market is efficient enough, government should protect private property rights, wherever market is not efficient enough, government should take action of macro-intervention to regulate market system with different methods.
Bibliography
Adam Smith: wealth of nations (Selected Edition). Oxford University Press, Walton Street, Pxford OX2 6DP
Alain Anderton: Economics (2nd Edition). Causeway Press Limited, PO Box13, Ormskirk, Lancs, L39 5HP
John Sloman: Essential of Economics (2nd Edition). Pearson Education Limited, Edinburgh Gate, Harlow, Essex, CM20 2JE England