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Outline the ways in which the price mechanism allocates resources in a free market economy.

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Outline the ways in which the price mechanism allocates resources in a free market economy In a free market economy, the price mechanism allocates resources through the forces of supply and demand; social costs, such as pollution and noise are not taken into consideration by individual firms. The firms produce on the basis of self interest ie what option brings the most profit, maximising behaviour and not considering external costs. The problem in a free market economy remains the same as in any other; what, how and for whom to produce. The individual firms must decide what proportion of capital and consumer goods should be produced to maximise the firms profits(we are assuming the firm is a profit maximiser) I would draw a demand/supply graph here The diagram shows what is supplied and demanded at any given price. This concept is essential for understanding resource allocation in a free market economy since resources are allocated depending on the demand for whatever good. ...read more.


The constant cycle causes uncertainty among consumers and firms. When the government increases interest rates, for example, as a means of reducing inflation, the economy may go into recession. In a price mechanism economy, certain undesirable market structures emerge, monopolies being one form. A monopolist may earn abnormal profits due to its ability to be the unique provider. This is undesirable, some production may fall due to the lack of competitivity and prices may rise, affecting consumers. In the U.S., Microsoft was attacked by anti trust lawyers for trying to create a monopoly which would be against the interests of consumers. Oligopoly may also prove to be bad, since cartels may be created thus again allowing firms to make abnormal profits by restricting competition and increasing prices. Inequality emerges in the price mechanism. Different social groups have different lifestyles due to the ability, or lack of it to buy goods. If the price mechanism worked for merit goods such as hospitals, then many poorer people would suffer from being unable to pay for it. ...read more.


Without government intervention, there would be no set uniform national curriculum. Those who could afford better education would be given better chances. The class gap would widen because the upper classes would obviously be able to pay for the best. The distribution of income would thus be almost non existent, due to the well off people being able to take on better qualified jobs. However, government intervention may lead to a lack of competitive efficiency in the education market. If no government intervention existed, then each school would constantly try to increase its competibility to get ahead of the others. The result would be ever increasing national levels(providing agreements between the schools were not formed.) If the price mechanism allocated teaching resources then better teachers would be better paid, thus increasing the incentive to work. However, if say for example, vouchers were issued by the government and parents were free to spend these on the schools of their choice, then the worse off schools may be ignored by parents thus causing small local schools to close down. ...read more.

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