How are resources allocated in a classical market economy? Based on the above definition, discuss the principles and mechanisms in allocating goods and services in Hong Kong.

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Student No: 10342923

Student Name: Leung Tak Man

TMA 4

Question:-

How are resources allocated in a classical market economy? Based on the above definition, discuss the principles and mechanisms in allocating goods and services in Hong Kong.

Answer:

A market economy is characterized by private ownership and intellectual property rights and de-centralized decision makings. Meanwhile, effective competition and free exchange of goods constitute the core of a market economy. Individuals and private firms make the major decisions about consumption and production. A system of prices, of markets, of profits & losses, of incentives & rewards together determine what, how and for whom (three basic problems of any economic organization) while the government keeps it policies off (laissez-faire) the market’s economic decisions (Samuelson, Nordhaus, 2001, pp. 8 - 9). Private firms produce the commodities that yield the highest profits (the what) by the techniques of production that are least costly (the how). Consumption is determined by individuals’ decisions about how to spend the wages and property incomes generated by their labour and property ownership ( the for whom) (Samuelson, Nordhaus, 2001, pp. 34 - 42).

In the market economy, the economic activities are co-ordinated in such a way that the three basic economic problems due to scarcity of resources and unlimited wants of human being are handled by the price system. Prices are determined via interplay between supply and demand and function as a rationing mechanism for the scare goods supplied by the economy. Economic decisions are resolved through the market mechanism in which prices coordinate the decisions of producers and consumer in the market to attain market equilibrium of supply and demand. For the first problem of what to produce, the price serves as the signal telling producers what goods to produce and in what quantity in order to maximize the profit. Regarding the second problem of hoe to produce, the least cost of production method (i.e. the least price of factors of production) will be chosen by the producers so as to maximize the profit again. The last problem of for whom to produce shall be solved by the distribution of the goods to people who are both willing and have the ability to pay the price of that good.

Prices are carrier of information to enterprises in a market economy and they reflects to the greatest degree possible the relative scarcity of the various goods and services (Isachsen, Hamilton, Gylfason, 1993, pp 110). In a market economy prices play a crucial part. Through prices, customers receive information concerning how much money they must sacrifice in order to obtain a product. Producers gain knowledge of how much revenue they can expext by producing and selling products. All necessary information in a well functioning market is inherent in prices (Isachsen, Hamilton, Gylfason, 1993, pp 13)

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Apart from the above, a market economy also has an inherent self-regulatory mechanism called “the invisible hand” (Isachsen, Hamilton, Gylfason, 1993, pp 34). The “invisible hand” steers the economic system as a whole to equilibrium where aggregate supply and aggregate demand are equal. The producer and consumer both measure alternatives against one another and choose what seems to be the best. If the price in the economy correctly reflect the scarcity of the various goods and services in the society, those decisions that are made on this basis will be good enough so that production become most efficient at ...

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