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

1. What to produce?

   • Determined by consumer demand and profit motive.

2. How to produce?

   • Firms use efficient production methods to minimise costs.

3. 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).