2.2 - The role of Markets in Allocating Resources

Question 1

The three main economic systems

Answer 1

• Market economy
• Planned economy
• Mixed economy

Question 2

Market economy

Answer 2

Economic decisions and the prices of goods and services are guided by the interactions of a country’s individual citizens and firms

Question 3

Planned economy

Answer 3

All of the resources are owned by the state and the government controls the distribution of goods and services

Question 4

What are the three basic questions of an economic system?

Answer 4

1. What to produce?
2. How to produce it?
3. For whom are the goods and services to be produced?

Question 5

How does the free market system address the three questions?

Answer 5

1. What: based on demand and supply (price mechanism)
2. How: most efficient, profitable way possible
3. For whom: those who can afford it

Question 6

How does the mixed economic system address the three questions?

Answer 6

1. What: based on demand, supply and the government
2. How: some efficiency but also a focus on welfare/well-being
3. For whom: those who can afford it, plus some provision to those who cannot afford it

Question 7

How does the planned economic system address the three questions?

Answer 7

1. What: The government
2. How: Ensure everyone has a job
3. For whom: Everyone

Question 8

Characteristics of a free market system (4)

Answer 8

• Works to allocate scarce resources efficiently, purely through the forces of demand & supply (the price mechanism)
• There is no government intervention in a pure market system (no taxes or government spending)
• In reality, there is no economy which is a pure market system
• In a market system, prices for goods/services are determined by the interaction of demand & supply

Question 9

Market

Answer 9

A market is a place where buyers and sellers can meet to facilitate the exchange or transaction of goods and services.

Question 10

The price mechanism

Answer 10

The price mechanism is the interaction of demand and supply in a free market
- this interaction determines prices which are the means by which scarce resources are allocated between competing wants/needs

Question 11

What are the main functions of the price mechanism in a market economy? (3)

Answer 11

• allocate (ration) scarce resources: resources become scarcer the price will rise further - only those who can afford to pay for them will receive them.
• if there is a surplus then prices fall & more consumers can afford them
• when prices for a good/service rise, it incentivises producers to reallocate resources from a less profitable market to this market in order to maximise their profits

Question 12

Market equilibrium

Answer 12

Equilibrium in a market occurs when
demand = supply

Question 13

Market disequilibrium

Answer 13

Any point (price) above or below the market price equilibrium
- occurs whenever there is excess demand or supply in a market