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In the free market system, the demand and supply work and react together. The price is a key device between them.

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Introduction

(a) In the free market system, the demand and supply work and react together. The price is a key device between them. The price determines the signalling between the two sides and acts as a balance. Because there are too many people and the system is too complex, price provides them to try to solve the economic problems such as allocate resources Forces within market Free market is where demand and supply meet with each other. Suppliers (firms, individuals) offer their products and services to sell in the market. People who's aims are demand for the products or services. The correlation between demand and price is inverse. If the price goes up, demand decrease and if price goes down, the result is, the quantity of demand will increase (P-Q). The direct relationship between supply and price provides that the higher the price the more quantity product or service produced by suppliers. The two forces work against each other and it lead to determine the market price, which tends to manage both sides to find the equilibrium (D=S - PeQe). There is normally no willingness to change this condition. If there is a changing in demand, the curve will move to the right (D') ...read more.

Middle

If there is a shortage for a particular job, companies will pay more who can carry out this work. People who got skill that relatively too many people have, he will receive low earnings. (b) In the theory of economics, the supply and demand system perfectly and automatically works in the free market and always an "invisible hand" helps to lead it to the equilibrium. So why the government still seeks to control prices at a level? Direct price control Sometimes the "invisible hand" just needs some help to get the market into the equilibrium for some reasons and the government directly has/wants to control prices. Minimum price (price floor) When the government sets the price on a minimum level and it is not allowed to fall below this, then we are talking about minimum price. One of the aims can be the legislation of minimum wages to protect the law of workers so the firms can not exploit them. (Introduced in 1894 in New-Zealand). The minimum wage level have to be higher than it is normally set by the market, otherwise it make no sense to introduce it. In most of developed countries this system works but this strategy can easily cause bigger damage than benefit if the labour market is in equilibrium1. ...read more.

Conclusion

It is good for the government because it helps to protect its residents from the harmful goods. Typical example the EU tobacco policy restricts produced quantities to fixed quotas and therefore people demand less for higher prices. Sometimes government wants to protect its domestic industry from international competition and the tariff on imported products tend to decrease its demand. EU sets barriers against countries outside of EU to protect the domestic market (especially agricultural products). Inside the EU countries do not have to pay tariffs between each other but out of EU countries have to pay tariffs if they want to sell their products in the market. Inverse provision of tariff can be used when a country has monopoly power in their supply and called export tax increases the prices. If the government does not want to burden its voters with big taxation, it is good way to raise its own revenue with tariffs. Sometimes accomplished government can obtain greater popularity before the election. If they play with the numbers and reduce the rate of direct tax but increases the rate of indirect tax thus it seems to be prices went down. In 1993, Bill Clinton American president proposed energy tax because among others he wanted to cut back the USA's deficit with the extra revenue from the oil tariff. ...read more.

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