Economics 2.9-10
2.9 Market Economic system
Concept of a market
A market is a place or system where buyers and sellers interact to exchange goods and services.
The forces of demand and supply determine prices.
Can be physical (e.g., supermarkets, retail stores) or virtual (e.g., online shopping, stock exchanges).
Economic Systems
Types of Economic Systems
Real-World Examples
Market Economy: Hong Kong has low government intervention, allowing businesses to operate freely.
Planned Economy: North Korea's government controls all industries and sets production quotas.
Mixed Economy: Singapore combines free-market policies with government intervention in housing and healthcare.
Resource Allocation in Each System
Market Economy: Resources are allocated based on consumer demand and profit motives.
Planned Economy: Government decides what, how, and for whom to produce.
Mixed Economy: Market forces exist, but the government intervenes to correct market failures.
What is a Market Economy?
A market economy/free market economy is an economy that has no government intervention in the allocation of resources and distribution of goods/services
There is no purely free market economy in the world but some countries have less government intervention than others
The type of economy → determined by how the three economic questions are answered .
This ultimately determines the amount of government intervention in an economy
Allocation of Resources in a Market System
Key Principles
What to produce? – Based on consumer demand and profit potential.
How to produce? – Firms choose cost-effective production methods.
For whom to produce? – Goods are produced for those who can afford them.
Pros and Cons of a Market Economy
✅ Advantages of a Market Economy
🌟 More Choices – Consumers have a wide variety of goods and services. (e.g., the U.S. has diverse products due to high competition)
⚡ Efficiency – Firms use resources effectively to reduce waste.
🚀 Encourages Innovation – Businesses invest in new technology and better products.
🔄 Quick Adaptation – Firms respond quickly to consumer demand.
🏛 Less Government Control – Decisions are made faster, without excessive regulations
❌ Disadvantages of a Market Economy
💰 Unequal Wealth Distribution – Only those who can afford goods benefit.
🚧 Market Failures – Important services (e.g., public transport, street lighting) may be underprovided.
📉 Job Uncertainty – Firms hire and fire based on profits, leading to unemployment.
☠ Harmful Goods Sold – Products like cigarettes and weapons may be widely available (e.g., cigarette advertising in Indonesia, where smoking rates are high)
🌍 Environmental Damage – Companies may exploit resources for profit.
🏢 Monopolies Can Form – Large firms dominate markets, limiting competition (e.g., Google and Amazon controlling global digital markets)
The Three Economic Questions in Resource Allocation
What to produce?
Determined by consumer demand and profit motive.
How to produce?
Firms use efficient production methods to minimise costs.
For whom to produce?
Goods/services are provided to those who can afford them.
Remember 💡
Pure market economies do not exist; most economies are mixed.
'Market economy' and 'free market system' are interchangeable terms.
2.10 Market failure
🌍 Definition of Market Failure
Market failure occurs when the production & consumption of goods and services cause unintended (good & bad) side effects on third parties indirectly involved in market of that good/service→ leading to an inefficient allocation of resources.
It results in:
📉 Overallocation of resources to harmful goods/services (e.g., pollution, smoking).
📈 Underallocation of resources to beneficial goods/services (e.g., education, healthcare).
Main Reasons for Market Failure
🏛 1. Public Goods
Non-excludable → No one can be stopped from using them
Non-rivalrous → One person using them doesn’t reduce their availability. (e.g., street lighting, national defence).
Market failure happens when people undervalue merit goods, leading to underconsumption (e.g., expensive education lowers school attendance).
How the gov fix it? (gov intervention): includes subsidies (lowering costs), public provision (free education/healthcare), and awareness campaigns (promoting benefits like vaccinations).
🎓 2. Merit Goods
Goods with positive externalities that are underconsumed (e.g., education, healthcare, vaccinations).
People undervalue these goods, leading to low demand.
How the government fixes it:
Subsidies – Makes merit goods cheaper.
Public provision – Government provides free education or healthcare.
Awareness campaigns – Ads promoting benefits like vaccinations.
🚭 3. Demerit Goods
Goods with negative externalities that are overconsumed (e.g., cigarettes, alcohol, gambling).
Governments use taxes, bans, and regulations to reduce consumption
⚖ Costs and Benefits
💰 1. Private Costs & Benefits
Private costs: Costs borne by producers/consumers (e.g., production costs, wages, raw materials).
Private benefits: Benefits received by producers/consumers (e.g., revenue, personal satisfaction).
🔄 2. External Costs & Benefits
External costs (negative externalities): Costs imposed on third parties (e.g., pollution, traffic congestion).
External benefits (positive externalities): Benefits received by third parties (e.g., improved public health from vaccinations).
📊 3. Social Costs & Benefits
Social cost: Private costs + external costs.
Social benefit: Private benefits + external benefits.
Market failure occurs when social costs exceed social benefits or vice versa.
⚠ Causes of Market Failure
🚨 1. Externalities
Negative externalities → Overproduction of harmful goods (e.g., air pollution from factories).
Positive externalities → Underproduction of beneficial goods (e.g., education and healthcare)
🏛 2. Public Goods
Free markets fail to provide these as firms cannot exclude non-payers.
🎭 3. Merit and Demerit Goods
Merit goods underconsumed; demerit goods overconsumed due to lack of awareness or price mechanisms.
🏢 4. Monopoly Power
Monopolies restrict output and increase prices, leading to inefficiency.
⚙ 5. Factor Immobility
Labour immobility causes unemployment if workers cannot move to new industries.
Capital immobility leads to wasted resources when factories/machines cannot be repurposed
⚡ Consequences of Market Failure
❌ 1. Overconsumption of Demerit Goods & Goods with External Costs
Demerit goods (e.g., cigarettes, alcohol) are overproduced due to high profitability and consumer addiction.
External costs such as health issues and environmental damage burden society.
Without government intervention, excessive resources are allocated to these goods.
✅ 2. Underconsumption of Merit Goods & Goods with External Benefits
Merit goods (e.g., education, healthcare) are underprovided as individuals undervalue external benefits.
Price elasticity of demand is high, meaning a small increase in price leads to a significant drop in demand.
Governments intervene via subsidies, free provision, or awareness campaigns.
💸 3. Economic Inefficiency
Misallocation of resources leads to inefficiencies in production and consumption.
Socially optimal levels of output are not achieved, causing welfare loss.
🌱 4. Environmental Degradation
Pollution, deforestation, & climate change result from unchecked external costs.
Governments use regulations, carbon taxes, & emission caps to reduce harm.
🏛 5. Need for Government Intervention
Taxation & subsidies help correct externalities.
Regulation & public goods address market inefficiencies.
Without intervention, market forces alone fail to achieve optimal societal outcomes.
⚠ 6. Government Failure
Sometimes, intervention worsens the problem (e.g., high taxes on cigarettes may increase black-market sales).