1.2 The Co Ordination Problem

Question 1

Define resource allocation

Answer 1

The way scarce resources are chosen to produce particular goods or services.

Question 2

How is resource allocation done in a pure market economy?

Answer 2

Supply and demand

Question 3

Why does the market economy rely on incentives ?

Answer 3

For scarcity to be solved EFFICIENTLY as agents want profit , high wages and rent etc.

Question 4

Who’s actions determine resource allocation and how?

Answer 4

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

Question 5

What are the objectives of a household?

Answer 5

• Satisfaction from consuming goods and services.

- Working to provide income

Question 6

What are the objectives of a firm?

Answer 6

Making profits and to receive a return on their efforts

Question 7

What are the objectives of a government?

Answer 7

Raise tax revenue, expenditure and provide a good framework for the economy to work within (achieve its macro economic objectives)

Question 8

Give an example of why the government might try to influence resource allocation directly?

Answer 8

Redistributing income to protect vulnerable members of society

Question 9

Define a market economy

Answer 9

Market forces guide the allocation of resources within a society

..( to achieve an equilibrium which maximises economic welfare)…

Question 10

Define a centrally planned economy

Answer 10

The government/ state decides on resource allocation

Question 11

Define mixed economy

Answer 11

Market forces and some state intervention are used to allocate resources.

Question 12

Define capitalism

Answer 12

System of production where there is private ownership of resources and minimal government interference
Individuals are free to pursue their objectives

Question 13

What is the governments role in a free capitalist economy?

Answer 13

State doesn’t directly intervene with production process but has a basic legal framework and basic property rights

Question 14

What was Adam Smith’s theory about resource allocation?

Answer 14

Invisible hand. Happens when consumers try to maximise satisfaction and firms maximise profit by responding to consumer demand THROUGH PRICE SIGNALS.

Question 15

Give an example of a centrally planned economy

Answer 15

Russia after its revolution 1917.

North Korea and Cuba still stick with central planning.

Question 16

Give advantages of a free market economy

Answer 16

• 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

Question 17

What are the disadvantages of a free market economy

Answer 17

• 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

Question 18

Why did many countries adopt planned economies in the 20th century?

Answer 18

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.

Question 19

Advantages of a COMMAND economy?

Answer 19

• 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

Question 20

Disadvantages of a command economy?

Answer 20

• 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