2)Allocation of resources

Question 1

Define resource allocation

Answer 1

The way in which societies factors of production are used among their alternative uses

Question 2

What do we assume about households, government, and businesses

Answer 2

Households- we assume they want to maximise their satisfaction/ welfare by consuming products that most increase utility relative to their price

Businesses- they want to allocate their resources to match the demands of consumers, competition incentivises them to reduce prices to increase sales and maximise profit

Government- wants to maximise tax revenue to provide services to consumers and businesses, whilst fulfilling an array of other objectives

Question 3

Evaluating usefulness of incentives

Answer 3

Positives-If lots of information available, incentives become more effective
- if agents are acting rationally, the incentives is more effective at allocating resources to fulfil agents objectives

Negatives- if agents act against their rational thinking, it reduces incentives effectiveness
- a lack of information may stop agents maximising their utility, so less able to act in accordance with their incentives

Question 4

Define a free market economy

Answer 4

market forces are allowed to guide the allocation of resources within a society

Question 5

Define capitalism

Answer 5

a system of production in which there is private ownership of productive resources, and individuals are free to pursue their objectives with minimal interference from government

Question 6

Define invisible hand

Answer 6

a term used by Adam smith to describe the way in which resources are allocated in an economy

Question 7

How are higher and lower prices signals to different economic objectives??

Answer 7

Higher prices are a signal to firms to increase supply and employ more labour, something to direct factors of production towards
lower prices are a signal for consumers to spend their wages on to maximise utility and purchasing power

Question 8

Benefits of a free market economy

Answer 8

• Lower costs and prices, products with the lowest price have the highest demand, incentivising firms to lower costs, increasing x efficiency
• entrepreneurship/ innovation- businesses are more inclined to use profits to take risks and improve the quality and range of products
• choice- innovation leads to a wider range of consumer products available

Question 9

drawbacks of a free market economy

Answer 9

• inequality of labour- labour with the highest strength and opportunities benefit from the highest salaries, allowing them to maximise utility more than low salary workers
• unprofitable products not made- even if they have a massive benefit to society eg street lamps, firms will leave it to the government. to supply
• monopolies- firms are incentivised to increase their monopoly share, allowing them to be price makers

Question 10

What is a planned economy??

Answer 10

decisions on resource allocation are guided by the state (also called command economy)

Question 11

How does a planned economy work

Answer 11

Planned economies have their direction driven by the government, who allocate resources without basing it on the price mechanism (regardless of demand), leads to a lack of allocative efficiency. There is no incentive to improve quality or range of products due to a lack of competition. They are incentives to produce the most amount of products they can in the easiest way

Question 12

Advantages of a planned economy

Answer 12

Better equality- government can ensure the basic demand of all households are met

• Low unemployment- no competition for jobs means governments can find most people a job
• prevents monopolies- government stops monopolies forming and abusing their power

Question 13

Disadvantages of a planned economy

Answer 13

• Poor decision making- no indicators or price mechanism to try and match supply with demand
• lack of risk taking and efficiency- no incentive to lower costs or reinvest revenue into improving products/ innovating

Question 14

Why is a centrally planned economy better than a free market one

Answer 14

• less inequality as basic needs and jobs provided to all of society, increasing overall utility of society
• no monopolies mean no abuse of households

Question 15

Why is a free market economy better than a planned one

Answer 15

• efficiency- firms in competition are incentivised to lower their average costs so they can Lower prices and maximise profits
• dynamic efficiency- firms want to reinvest their profits to innovate products through R and D, or risk take and diversify their product range
• better allocation of resources- price mechanism allows firms and government to better match supply and demand

Question 16

Define a mixed economy

Answer 16

resources are allocated partly through price signals and partly by government

Question 17

what are the features of a mixed economy

Answer 17

Mixed economies like GB have a private sector and a public sector.

• private sectors are free to make their own decisions and allocate resources how they want
• public sector is provided by the government to provide products that have little incentive to be provided by the firms/ would not work efficiently if left to the free market due to under consumption

Question 18

Benefits of a mixed economy

Answer 18

• A mixed economy benefits from the advantages of the free market; the price mechanism acts to best allocate some resources, and the choice and lower prices afforded to households maximises utility.
• The free market is harnessed to best allocate resources in areas that the price mechanism aligns the profit motivation of firms with the utility motivation of households.
• the government can still increase equality by mandating the public sector to provide free high quality services that are unaffordable to many households, such as education and healthcare, funded by taxes from the private sector

Question 19

Drawbacks of a mixed economy

Answer 19

• market failure- the free market may be unable to efficiently allocate resources
• government failure- government intervention may lead to a misallocation of resources
• drawbacks of free market and planned economies- inequality, non profit products not provided by private sector who are usually more efficient

Question 20

Why a larger private sector is more favourable

Answer 20

-assuming rationality, firms and households know best how to maximise utility and profit. this increases the happiness of society and profitability of firms, which can be taxed to fund the public sector.

Question 21

Why a larger public sector is more favourable

Answer 21

-Improving public services offered by the public sector, such as healthcare, education and the transport network, is investment that increases productivity of current workers, future workers and businesses. This increases the long run economic growth potential of an economy.