1.2 ALLOCATION OF RESOURCES

Question 1

What is an economic system

Answer 1

network of organisations engaged in a society to allocate scarce resources to try and maximise social welfare

Question 2

What are the 3 things that have been attributed to the demise of communist systems?

Answer 2

1. Planners lacked incentives to reallocate resources between industries efficiently and lacked incentive to improve the quality of production
2. Consumers lacked incentive to change their behaviour
3. Workers lacked incentives to increase their productivty, and planning lead to inefficient investment, further reducing productivity

Question 3

How did market based systems solve the problem with communist based systems

Answer 3

• market based systems provide incentives for producers to innovate and enter or leave markets, via the price mechanism
• the price mechanism also incentivizes consumers to change consumption behaviour

Question 4

What was the problem of government failure in centrally planned economies replaced with?

Answer 4

It was replaced with market failure, which is why a mixed allocation is optimal

Question 5

What are the 8 market oriented policies?

Answer 5

1. Fiscal Discipline - having control of government budgets and deficits to ensure low tax rate
2. Tax Reform - widening tax base (more people pay) and lowering tax rates so there is a wealth creation incentive
3. Property Rights - protecting intellecutal property and other rights to encourage innovation and entrepreneurship
4. Deregulation - lowering entry and exit requirements for markets
5. Liberalising Exchange Rates - free floating exchange rates
6. Liberalising Financial Markets - allowing financial markets more freedom with interest rates and allocation of finance
7. Privatisation - transferring state owned assets into private sector to increase economic efficiency and productivity
8. Trade Liberalisation - removal of import tarrifss and protectionism

Question 6

Why do private companies need restriction/ why a mixed allocation economy? (6)

Answer 6

• overcome possibility of market failure
• discourage abuse of market power
• ensure sustainable use of resources
• protect against worker exploitation
• ensure protection of local culture
• protect domestic businesses from impact of MNC’s (in strategically important industries)

Question 7

What are the advantages of free-market competition (5)

Answer 7

1. More efficient allocation of resources
2. Competition which incetivises innovation and invention (more profit for better products)
3. Profit will also stimulate investment (as firms with better capital will have more efficient production and economies of scale)
4. Competitive prices and increased consumption mean increase in real GDP and real GDP/capita
5. Competition in the from of international trade will mean reduced domestic monopoly power (and increase quality or decrease price)

Question 8

What are the 8 possible disadvantages of centrally planned economies?

Answer 8

1. bureaucratic costs of central planning (can lead to higher average costs)
2. central planners are unlikely to be as accurate as the market in determining suitable equilibrium prices (may lead to shortages or surpluses)
3. absences of incentives for workers and businesses can mean low productivity and levels of over-employment
4. there is a lack of incentive to innovate and low productivity can also lead to state run businesses suffering large losses
5. the state is slow to react to changing consumer wants and preferences
6. the state suffers from information failures and may make decisions on poor and inaccurate decisions
7. higher risk of corruption (damages social welfare)
8. state run businesses are at risk of poor investment decisions as they try and fulfil narrow political motivations rather than maximising social welfare

Question 9

What are the 10 things the state should provide in a mixed economy

Answer 9

1. The state should provide and subsidise the production of merit goods (education and healthcare)
2. Ensure there is equality in opportunity, so all children have a good quality of education which is accessible
3. Provide key infrastructure such as power and transportation network
4. Provide public goods that the market fails to provide or under provides
5. Provide sound institutions of governance
6. interventionist policies against instability in currency markets
7. welfare provision for a basic safety net to reduce poverty
8. progressive taxation and state spending to reduce income inequality
9. active regional and industrial policies
10. public/private partnerships to increase economic efficiency in markets where natural monopolies from (state subsidies needed to promote efficiency)