1.2 The Co Ordination Problem Flashcards
Define resource allocation
The way scarce resources are chosen to produce particular goods or services.
How is resource allocation done in a pure market economy?
Supply and demand
Why does the market economy rely on incentives ?
For scarcity to be solved EFFICIENTLY as agents want profit , high wages and rent etc.
Who’s actions determine resource allocation and how?
Households, firms and governments
Households- take role of consumers but also of workers
Firms- need to decide what to produce and about the production methods
Governments- impose tax, spend money and regulate economic activity
What are the objectives of a household?
- Satisfaction from consuming goods and services.
- Working to provide income
What are the objectives of a firm?
Making profits and to receive a return on their efforts
What are the objectives of a government?
Raise tax revenue, expenditure and provide a good framework for the economy to work within (achieve its macro economic objectives)
Give an example of why the government might try to influence resource allocation directly?
Redistributing income to protect vulnerable members of society
Define a market economy
Market forces guide the allocation of resources within a society
..( to achieve an equilibrium which maximises economic welfare)…
Define a centrally planned economy
The government/ state decides on resource allocation
Define mixed economy
Market forces and some state intervention are used to allocate resources.
Define capitalism
System of production where there is private ownership of resources and minimal government interference
Individuals are free to pursue their objectives
What is the governments role in a free capitalist economy?
State doesn’t directly intervene with production process but has a basic legal framework and basic property rights
What was Adam Smith’s theory about resource allocation?
Invisible hand. Happens when consumers try to maximise satisfaction and firms maximise profit by responding to consumer demand THROUGH PRICE SIGNALS.
Give an example of a centrally planned economy
Russia after its revolution 1917.
North Korea and Cuba still stick with central planning.
Give advantages of a free market economy
- suppliers produce what consumers want so there is choice for us
- efficient due to incentives (more products lower costs)
- automatically reacts to changes in supply and demand to ensure economic welfare is achieved
What are the disadvantages of a free market economy
- Ignores externalities
- Income inequality occurs
- Price instability as well as growth and unemployment (links to macro objectives)
- Could result in monopoly- restricted supply and high prices
- Doesn’t work for public goods
Why did many countries adopt planned economies in the 20th century?
Karl Marx’s ideas encouraged this Governments would base economic decisions on wants of a populations and then decide what to produce and how production should be allocated.
Advantages of a COMMAND economy?
- Externalities can be considered and monopoly power controlled.
- Can prevent undesirable levels of unemployment growth and prices.
- Inequality could be reduced
- Welfare > Profit
- Easier co ordination of resources during crisis like war
Disadvantages of a command economy?
- Less competition so incentive to be efficient is lessened.
- Based on judgements that may not reflect consumer preferences
- Governments also fail
- Limiting democracy and personal freedom
