Market Economy Flashcards
Market economy
An economic system that’s based on resources being allocated through the forces of supply and demand
Price mechanism
A method of allocation of resources by the movement of prices
What are consumers and firms motivated by?
Utility and profit maximization
Why does the market achieve allocative efficiency without gov intervention?
Because of the price mechanism
How is excess demand eradicated in a market economy?
Prices increase so that there is an extension on the supply curve and contraction on the demand curve
1. Rationing
- low income households are rationed out of the market as they can no longer afford the good at higher prices
2. Signalling
- signals outside firms to enter the market as they can make more profit as more profitable to supply at higher prices
3. Incentive
- incumbent firms are incentivized to invest more into this market
How is excess supply eradicated in a market economy?
Prices decrease so that there is an contraction on the supply curve and extension on the demand curve
1. Rationing
- low income households come into the market as they can now afford the good at lower prices
2. Signalling
- signals outside firms to leave the market as they make less profit as less profitable to supply at lower prices
3. Incentive
- incumbent firms are incentivized to invest less and leave this market
Why does the government intervene in the market?
If you let this be, there will be market failure and externalities
- could also lead to there being a missing market (free rider problem)
Public goods in a pure market economy
- in a pure market economy there will be no provision of public goods because of the Free Rider Problem
Free Rider Problem
- the private sector don’t want people to consume the good for free and so don’t supply at all
- so the market goes missing and there’s complete market failure
Advantages of Market Economies
1. Allocative efficiency
- eradicates excess supply as prices would decrease
- extension on demand curve and contraction on supply curve
- signals firms to leave the market, incentivizes firms to invest less, rations consumers into the market
2. Productive efficiency
- lots of production capacity as lots of competition
- firms employ all their fop efficiently in order to not get pushed out the market
3. Competition
- the more price competition which is good so more goods and services at lower prices
- consumers retain more RDY so larger consumer surplus
4. Quality and innovation
- non-price competition as firms more incentivized to produce higher quality goods and innovate to outcompete other firms
- if they don’t they may be pulled out the market by more innovative firms and consumers buy from other substitutes
5. Choice
- high choice for consumers and so can maximize utility
6. Higher levels of entrepreneurship
- there’s a big incentive to own a business as lots of profits can be made
- government gets a lot of tax revenue
- unemployment decreases so lots of econ growth
7. Higher levels of productivity
- in a free market no benefits are given so people are incentivised to do better in their job
- less jobs security has less regulation so may work hard out to not get fired
- voluntary unemployment decreases
8. High levels of economic growth
- productivity increases so output increases so greater GDP
Disadvantages of Market Economies
1. Market failure
- in a free market economy firms only care about their private costs and households only care about utility maximization
- privatetheirphones don’t want to provide goods for free so public goods won’t be provided
- under consumption of goods that provide positive externalities such as healthcare
2. Income inequality
- in developing countries can only go to school if can afford
- lower income households can’t afford education so gain no skills so only get low paying jobs in the future
- lots of capital labels substitution
- no welfare state so lots of people in absolute poverty
- if healthcare is provided by the private sector the poor contour Ford and so sick for longer so can’t work
3. Concentrated competition
- if one firm dominates the market and has all market share, won’t be lots of close substitutes so able to charge higher prices
- may lead to collusions when two big companies come together and fix prices
- lack of innovation if one firm dominates the market
4. Public goods
- never provided in the free market as they are usually non-excludable which means everyone can buy them for free
- producers do not want to supply the good for free and so the market goes missing
- complete market failure
