Year 1 micro - different types of markets Flashcards
what is a market economy
an economy where the private sector owns all resources in the economy and allocates goods and services through the market mechanism
what is a command economy
an economic system where all decisions about how to allocate resources are made by the government
what is a mixed economy
an economic system that allows for some government intervention where the market fails to allocate resources efficiently
market economy vs command
- profit motive in market, welfare maximisation in command
- high freedom of choice in market, lower in command
- competition higher in free market
- role of government low in free market
- variety and quality of goods and services higher in market
- quicker respond to demand in market economies, slow in command
- more inefficient in command
- merit goods are under provided and demerit goods are overprovided, compared to command
- under provision of public goods in market economy
- higher income inequality in market
- monopolies in market economy, none in command
why is the quality and variety of goods and services higher in a market economy
- there’s a high incentive to maximise profits and produce goods and services that consumers want/need
- so they will want to produce a variety of goods to satisfy consumers
What is a free market?
Any place where buyers meet sellers to exchange goods and services, free from government intervention
what happens at allocative efficiency
- resources perfectly follow consumer demand
- society surplus if maximised
- net social benefit is maximised
pros of free market economy
🔹 1️⃣ Allocative Efficiency → Optimal Resource Use
In a free market, prices are determined by supply and demand, ensuring resources are allocated efficiently.
Firms must respond to consumer preferences, producing goods and services that are in high demand.
If resources are misallocated (e.g., too much of a good is produced), firms adjust prices and output accordingly.
This leads to consumer satisfaction and ensures that scarce resources are not wasted.
📌 Example: The tech industry responds quickly to consumer demand, ensuring new products (e.g., smartphones) match consumer preferences.
🔹 2️⃣ Incentives for Innovation & Dynamism → Long-Term Growth
In a competitive free market, firms have an incentive to innovate to gain a competitive edge.
Innovation leads to better products, improved efficiency, and lower costs over time.
As firms become more productive, economic growth increases, raising living standards.
This creates a cycle of reinvestment, where firms use profits to fund further R&D.
📌 Example: Tesla’s advancements in electric vehicles were driven by the desire to compete in the automobile market.
🔹 3️⃣ Consumer Sovereignty → Greater Choice & Lower Prices
In a free market, firms must compete to attract customers, which forces them to improve quality and lower prices.
Monopolies are less likely to emerge because new entrants can challenge established firms.
Consumers benefit from a wider range of goods and services at competitive prices.
This ensures that firms remain customer-focused, constantly improving their products.
📌 Example: The supermarket industry has a wide range of choices (e.g., Tesco, Aldi, Lidl, Sainsbury’s), keeping prices competitive.
🔹 4️⃣ Productive Efficiency → Cost-Effective Production
Firms in a free market must minimise costs to remain competitive.
This forces businesses to find the most efficient production methods, reducing waste.
Over time, this leads to lower prices for consumers and higher profitability for firms.
As firms produce closer to their lowest average cost, the economy becomes more efficient overall.
📌 Example: Amazon’s use of automation and AI has reduced costs, allowing fast delivery and competitive pricing.
🔹 5️⃣ Economic Growth & Higher Living Standards
Increased efficiency, competition, and innovation contribute to higher productivity.
This leads to higher GDP, increased job opportunities, and rising wages.
A growing economy enables higher tax revenues (even with low tax rates), which can fund public services.
Over time, higher incomes allow more people to afford better healthcare, education, and housing.
📌 Example: Countries with strong free-market policies (e.g., Singapore, USA) tend to have higher GDP per capita and higher living standards.
cons of free market economy
🔹 1️⃣ Market Failure & Inequality
In a free market, profit maximisation is the main goal, leading firms to focus on profitable markets.
Essential services like healthcare and education may be underprovided if they are not profitable.
This leads to unequal access to basic needs, widening income and wealth inequality.
Over time, social tensions may rise, and poverty can persist despite economic growth.
📌 Example: In the US healthcare system, many low-income individuals cannot afford treatment due to high costs.
🔹 2️⃣ Monopoly Power & Exploitation
Without government intervention, firms may dominate industries, creating monopolies or oligopolies.
Lack of competition allows firms to charge higher prices, reducing consumer surplus.
Workers may be exploited with low wages and poor working conditions if labour laws are weak.
Over time, wealth and power concentrate in a few large firms, reducing market efficiency.
📌 Example: Big Tech firms (Amazon, Google, Apple) dominate markets, making it hard for small businesses to compete.
🔹 3️⃣ Public Goods Underprovided
Public goods like street lighting, national defence, and policing are non-excludable and non-rivalrous.
Since firms cannot profit from them, the free market fails to provide these goods adequately.
Without government intervention, there is a free-rider problem, where people benefit without paying.
As a result, public services deteriorate, affecting safety and security.
📌 Example: Private companies won’t provide street lighting, as they can’t charge everyone who benefits.
🔹 4️⃣ Externalities & Environmental Damage
Firms focus on maximising profits, often ignoring negative externalities like pollution.
Overuse of natural resources can lead to deforestation, water shortages, and climate change.
Without regulation, firms avoid costs of reducing pollution, worsening long-term environmental damage.
This creates market failure, where private incentives do not align with social well-being.
📌 Example: Oil companies extracting fossil fuels contribute to climate change but don’t bear the full cost of the damage.
🔹 5️⃣ Short-Term Focus & Economic Instability
Firms prioritise short-term profits rather than long-term investment in research and development (R&D).
This can slow innovation and reduce long-term economic growth.
Financial markets may engage in excessive speculation, leading to asset bubbles and economic crashes.
Economic instability increases uncertainty, discouraging both consumer and business confidence.
📌 Example: The 2008 Financial Crisis was caused by banks taking excessive risks in pursuit of short-term profits.
What is specialisation?
The concentration of production on a narrow range of goods or services
advantages of specialisation
Higher Output Leading to Higher Incomes
- Specialisation enables workers and firms to focus on tasks they are most skilled at, increasing output.
- As output rises, firms generate more revenue, which can lead to higher wages for workers and greater profits for businesses.
- This leads to overall economic growth and higher living standards in the long term.
Wider Range of Goods and Services
- Specialisation allows different regions and countries to produce goods they excel in, enabling trade.
- This results in a more diverse market, offering consumers a greater variety of goods and services.
- Access to a broader range of goods can enhance consumer satisfaction and living standards.
Greater Allocative Efficiency
- Resources are allocated more effectively as production focuses on goods and services where countries or firms have a comparative advantage.
- This reduces waste and ensures that resources are directed toward their most productive uses.
- Improved allocative efficiency benefits the economy by maximizing utility from available resources.
Increased Productivity
- Repetition of tasks through specialisation improves worker skills and efficiency, leading to higher productivity.
- Firms can invest in specialized machinery and processes that further enhance efficiency.
- Higher productivity lowers costs per unit, allowing firms to remain competitive and potentially reduce prices for consumers.
disadvantages of specialisation
🔹 1️⃣ Over-Reliance on Specific Sectors → Structural Unemployment
If an economy or firm specialises too much, it becomes over-dependent on one industry.
If demand for that industry falls due to technological change or external shocks, jobs are lost.
Workers with specialised skills may struggle to find alternative employment.
This leads to structural unemployment, reducing incomes and increasing government spending on benefits.
📌 Example: The decline of coal mining in the UK led to long-term regional unemployment.
🔹 2️⃣ Lack of Skill Diversification → Occupational Immobility
Workers who perform the same tasks repeatedly develop specific skills but may struggle to adapt if industries change.
If a worker is highly specialised, retraining for a new job can be time-consuming and expensive.
This reduces labour market flexibility, slowing economic growth.
In the long run, economies may face labour shortages in key sectors.
📌 Example: Factory workers who lost jobs due to automation found it hard to switch to tech-based roles.
🔹 3️⃣ Reduced Motivation & Productivity → Lower Efficiency
Workers who perform the same repetitive tasks may become bored and demotivated.
Lower job satisfaction can lead to absenteeism and higher staff turnover.
Over time, productivity may decline, reducing the efficiency gains of specialisation.
This can lead to higher recruitment and training costs for businesses.
📌 Example: Assembly line workers in car manufacturing often experience burnout due to repetitive tasks.
🔹 4️⃣ Increased Vulnerability to External Shocks → Economic Instability
If an economy is highly specialised in a particular industry, it is more exposed to global market fluctuations.
A sudden price drop or supply chain disruption can cause economic instability.
This can affect GDP growth, employment, and government revenues.
Countries may struggle to recover quickly if they lack a diversified economy.
📌 Example: Oil-dependent economies (e.g., Venezuela) suffered severe recessions when oil prices crashed.
🔹 5️⃣ Over-Specialisation in Primary Goods → Terms of Trade Decline
Many developing countries specialise in primary goods (e.g., agriculture, raw materials).
Over time, commodity prices tend to fall, reducing export revenues.
Meanwhile, prices for imported manufactured goods rise, worsening the terms of trade.
This makes it harder for these countries to develop and diversify.
📌 Example: African economies reliant on coffee and cocoa exports face volatile incomes due to price fluctuations.
for specialisation to work, what needs to happen
- there needs to be mutually beneficial trade, countries need to be able to export their surplus of goods/services that they are efficient at producing and import those that they are inefficient at producing
what is division of labour
breaking down the production process into separate tasks upon specialisation
advantages of division of labour and specialisation
1.increased productivity
- division of labour allows workers to focus on specific tasks, developing specialised skills and increasing their efficiency in that task
- higher productivity boosts total output, reducing production costs and potentially lowering prices for consumers, making products more accessible
- time savings
- by dividing tasks, workers avoid the time lost in switching between tasks, which enhances work flow and reduces downtime
- faster production cycles allow firms to increase output and meet demand more efficiently, leading to quicker delivery and higher customer satisfaction - Skill development
- specialisation enables workers to build an expertise in a single task, leading to higher quality and precision in their work
- improved skill levels result in better quality goods and a more reliable production process - Technological innovation
- repetitive tasks encourage the development of new techniques and machinery to simplify work, as workers and managers identify efficiencies
- innovation in processes and technology reduces costs, further enhancing productivity and leading to more advanced and competitive products - efficient use of resources
- workers focusing on specialised tasks reduce waste of time, effort, and materials, achieving greater efficiency with the resources at hand
- efficient resource use optimises output, conserves resources, and allows firms to reinvest savings into other areas
disadvantages of division of labour and specialisation
- alienation
- repetitive, specialised tasks can lead to worker boredom and dissatisfaction, they may feel disconnected from the overall production process
- this can reduce motivation, lower productivity, and increase turnover, potentially raising recruitment and training costs for firms - loss of skill flexibility
- focusing on one narrow task reduces workers adaptability and limits their ability to adapt to diverse roles
- in a rapidly changing market, businesses may struggle with a workforce lacking broad skills, making it harder to adapt to new processes or product changes, may lead to structural unemployment - Potential for over reliance on automation
- specialisation can often encourage automation, reducing job opportunities and increasing workers’ risk of job losses in favour of machines
- over reliance on automation can limit job security, harming workers and potentially reducing the firms responsiveness to changes that require human flexibility and oversight
what are primary commodities
essential materials for economic activity, eg wheat, rice, copper, oil, gas
why are prices of primary commodities so volatile?
- PED and PES very price ineslastic, demand is inelastic because a lot of these commodities are necessities and there are no good substitutes available, PES is because there is a large production time lag involves. its also hard to store these
- there are regular demand and supply shifts. eg weather shifts supply and global growth affects demand
is price volatility an issue, why or why not
- depends on whether price goes up or down
- if prices go up, producers income, revenue will rise as ped is inelastic
- if prices fall, revenue and profitability etc will come down, in a developing country this may mean aboslute poverty for producers
- the revenue from price commodities could often provide big government revenue through tax. decrease price means less govt rev
- export revenue will decrease impacting economic growth, may lead to a recession in countries who are dependent on revenues from primary commodities
- lower incentive for producers to invest
how do economists make a theory
- they observe consumer behaviour
- they form hypothesis
- they make predictions from hypothesis
- they use evidence to test predictions
what is a positive statement
a statement which can be tested or backed up with evidence
what are normative statements
opinionated statements based on value judgement
what is specialisation
when workers or firms concentrate on producing a narrow range of goods or services.
