Explain and illustrate the roles played by profit in allocating scarce resources within the economy over time.

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(a) Explain and illustrate the roles played by profit in allocating scarce resources within the economy over time.                                                                          [10m]

Profit being a form of return from risk-taking and entrepreneurship, plays a significant role in allocating limited factors of production (land, capital, entrepreneur, labour) in the economy over time. It acts as a signaling mechanism in the free market system and funds capital investment so as to generate more returns in the future. Furthermore, it serve as an indicator to producers on what and how much to produce, how to produce and for whom to produce. This allows them to allocate scarce resources effectively and hence, maximize profits.

Traditionally, the objective of every firm is to maximize their profit. This can be done by producing at the output level where marginal revenue=marginal cost (MR=MC). At this point, the additional revenue that a firm would earn by selling one more unit of good would be equivalent to the additional cost required to produce it. Hence, firms would allocate their resources to increase output till this point as reflected in the diagram A.

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As shown in Diagram A, producing at output level, Q1 would result in a profit earned reflected by the blue border box. However, the firm is not producing at the optimal output level of Q2 which generate the highest possible profit as reflected by the red border box. Hence, profit-driven firms would be motivated allocate more scarce resources to increase their output level to Q2 to maximize profits. Therefore, this shows that potential profit is able to drive allocation of scarce resources to achieve profits maximisation.


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An excellent piece of work that achieves its purpose well

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This essay is structured well, having a clear introduction and conclusion. However, a clear introduction usually means the essay stays focused on the task, whereas this essay tends to move away from the question. It is vital that any unnecessary points are removed, as it makes an argument less convincing! Spelling, punctuation and grammar are strong and technical terms are used throughout.

The analysis in this essay is sound. The introduction clearly defines profit, however it was a shame to see normal profit not explored. In economics, normal profit includes the cost to the entrepreneur to stay in the industry, and so where total costs equal total revenue a normal profit is made. This is not to be confused with other subjects whereby profit is simply revenue minus costs. In the case of economics, if total revenue exceeds total costs, this is supernormal profit. Profit maximisation is well explained, and I liked there is a clear explanation of why a firm products at MC=MR. Often, this condition is asserted rather than explained, and the second paragraph is a great example of explaining this in a concise way. Being able to show such understanding will gain credit. Diagrams are used well, and are explained fluently. Being able to describe the diagram and explain the mechanisms, rather than simply including diagrams and asserting knowledge, will gain plenty of marks! What is missing from the diagrams is a discussion of the two efficiencies. I would've liked to have seen an awareness of allocative efficiency (P=MC) and productive efficiency (lowest point on average cost curve) and how profit will affect whether these efficiencies occur. I liked how they discuss external factors affecting resource allocation, as it is clear that most economies are no longer free market and so there is always an element of government intervention. Such perceptive analysis will gain credit.

This essay engages well with the question. There is a sustained awareness of why profit is crucial in acting as mechanism. I would've liked to have seen this essay explore efficiency more, as that is what the question is implicitly asking. Yes, efficiency is discussed, but it isn't the focus of the essay. There needs to be exploration of allocative efficiency and productive efficiency, and why profit ensures these are reached. I wasn't too sure why they discussed "not all firms seek to maximise profits" as this isn't prompted in the question. It is crucial to stay on focus!