econ chapter 2.2 (the role of markets in allocating resources) Flashcards
what does the size of an economy depend on
the number of people and firms involved
How does a market system work
works to allocate scarce resources efficiently through the forces of demand and supply.
What does a market system consist of
buyers and sellers who are willing and able to sell at a given price
What are the three key allocation decisions?
-what to produce?
-how to produce it?
-who is to receive the products manufactured
Why do the three allocation decsions have to be made?
Because of the basic economic problem of unlimited wants exceeding finite resources
What are the different economic systems?
-planned economic system
-mixed economic system
-market economic system
What is the market system?
-the system of allocating scarce resources through market forces of demand and supply
What is market equilibrium?
exists when the demand for a product matches the supply. There is no excess demand (causing shortages) or excess supply (surplus)
What is market disequilibrium?
A situation where demand and supply are not equal. Occurs if the price for a product is too high (resulting in a surplus) or if its too low (resulting in shortage.
What is the price mechanism?
the system of relying on the market forces of demand and supply to allocate resources
What is an economic system
The institutions, organisations and mechanisms that influence economic behaviour and determine how new resources are allocated
What is a planned economic system
An economic system where the government makes the crucial decisions. Land and capital are state owned and resources are allocated by directives.
What are directives?
state instructions given to state-owned enterprises
.
What is minimal in a market system?
Government intervention-land and capital are privately owned. Private sector firms decide how to produce the products consumers want to buy
When is a firm/industry capital-intensive?
when it employs large amounts of capital relative to labour.
e.g car maufacturing
When is a firm/industry labour intensive?
when a high proportion of labour relative to capital is used
e.g agriculture
what is a market economic system?
An economy where consumers determine what is produced. They signal their preferences to sellers through the price mechanism
Who execise maximum influence on what is produced in a market economic system
those who earn the highest incomes.
What do markets consist of?
buyers (who demand a particular good or service) and sellers (suppliers of a particular good or service)
What happens as a result of the price mechanism?
the market system establishes market equilibrium where demand equals supply; at this position the market does not have any shortages or surpluses
What happens at equilibrium price and quantity?
all products offered for sale at that price are bought by consumers
What does it mean if the price of a product is above the equilibrium price?
the product is deemed to be too expensive for consumers, so the quantity supplied will exceed the quantity demanded
can perfect equilibrium be achieved?
No, perfect equilibrium is nearly impossible to achieve because of:
Changing market conditions (shifts in demand and supply)
Imperfect information (buyers and sellers lack full knowledge)
Production and time lags (supply takes time to adjust)
External shocks (natural disasters, economic crises)
Price stickiness (prices don’t adjust instantly)
What does it mean if the price of a product is below the equilibrium?
the product is deemed to be too cheap to attract sufficient supply, so the quantity demanded will exceed the quantity supplied, creating a shortage.
What must happen if the price of the product is above equilibrium price?
prices must be reduced
What must happen if the price of the product is below equilibrium price?
the price must be raised.
What determines the fundamental economic questions in a market system?
the private sector
For example, wage rates are determined by the forces of demand for labour (by private sector firms) and supply of labour (by workers who offer their labour service)
What are features of the price mechanism?
-There is no government intervention in economic activities
-resources are owned by private economic agents who have economic freedom to allocate scarce resources
-Goods and services are allocated on the basis of price and financial incentives- a higher price encourages more supply while a lower price encourages consumer spending
How would you succinctly analyse the functions of the price mechanism?
The price mechanism allocates resources through three key functions:
Signaling function – Prices adjust to reflect changes in supply and demand, signaling firms to increase or decrease production.
Incentive function – Rising prices encourage producers to expand supply for higher profits, while falling prices motivate consumers to purchase more.
Rationing function – When goods are scarce, higher prices ration demand, ensuring resources go to those who value them most.
This ensures efficient allocation of resources in a free market with
