1.2 The allocation of resources

.

an economic system? + two perspectives to look at them / define them?

an economic system

- “a network of organisations + institutions engaged within a society to allocate scarce resources in order to maximise social welfare”

Could say its on a spectrum.

could be defined by how resources are allocated (allocation) or ownership

3 areas of spectrum defined by method/system of allocation of resources?

Pure/Planned - resources are allocated by control of the state/Govt (planning mechanism), outside/without market

Mixed - contains large market + non-market sectors. Resources are allocated by market forces + partly by the state

Market - resources are allocated by price mechanism in markets (“market forces”)

3 areas of spectrum defined by ownership of economy?

Communist - the means of production / factors of production are commonly (publicly) owned

Mixed - contains both large private sector and large public sector. Mixed ownership of the means of production.

Capitalist - the means of production are privately owned

a Market? + said to operate freely when… prices…, individual sellers and buyers…, overall…

a Market - “where buyers + sellers meet to trade/exchange g+s“

Market is said to operate freely when individual buyers and sellers:

• Prices convey information about market participants’ self-interests and the opportunities in the market

• Trade with reference to their own self-interests + to the alternatives open to them

• + so overall, decide what, how much + when to trade

(Completely decentralised - no central authority to decide how the market functions (eg. Quantity traded). Buyers and sellers make decisions without any intervention)

Price mechanism? (SIR). Incentives of each economic agent

Signalling - a change in price (gives clear information about market conditions to buyers + sellers)/ (signals/indicates that there is excess supply or demand)

 

Incentive - Price creates incentives/(motivates) consumers/producers to (make decisions consistent with)/(buy/sell more or less of a product, when the price paid helps to) (meet(ing) their objectives based on their self-interest)(maximise their overall utility/profits)

 

Rationing - allocates + rations scarce resources to households + firms who are most w+a to pay the most/ the price in the pursuit of their self-interests.

Incentives:

Households - generally buy g+s to maximise utility

Firms - supply/produce g+s to maximise profits; have an incentive to sell at highest price

Govt - need to understand incentives in order to influence economic activity (production and consumption)

—> So restricts allocation of resources to each g/s

Why historically have planned economies and communist economies typically not worked out? (think about for each role in a planned/communist economy (planners, consumers, workers)

Can be attributed to a lack of incentives in a planned system:

PLANNERS: (Govt usually) often lacked incentive to…:

• reallocate resources between industries efficiently

• Improve the quality of production

• Inefficient investment decisions —> limits productivity

CONSUMERS: had little incentive to change purchasing behaviour (lack of price mechanism means lack of incentives related to price (diff prices you can get in the economy + changing prices…)

WORKERS: lacked incentive to increase productivity (no chance of bonuses, promotions etc.)

Planned economies seems to have problems of Govt failure

Impact of lack of Price mechanism?

Market based systems provide incentives via the price mechanism eg for

• Producers to leave or enter industries/market

• Consumers to change their purchasing behaviour based on price

 

So prices ration + allocate resources based on the preferences of demand + supply due to price in a market

But problem(s) with Market systems too?

Market Failure (other factors such as externalities, information failure that doesn’t actually maximise social welfare)

Optimal economy?

likely to include a mixed ownership and allocation.

The extent to which markets should be left to allocate resources will continue to be an ongoing debate (to what extent should government intervene in allocation and/or ownership?)