13.

1 The Market Economic System

Resources move automatically according to price changes

Remember the Price Mechanism: the way decisions by

households and firms interact to decide the allocation of
resources.
Basically the interaction between Demand and Supply.

The goal in a market economy is equilibrium price.

When Demand and Supply meet at the same price

If there is excess demand leads to a shortage so we need

to increase the price

Excess supply (due to decrease in demand) leads to a

surplus and we need to lower the price

Draw the diagrams in 13.1

Individual Activity 1

1. Draw 2 diagrams:
one showing the demand and supply curves for the
price of onions.
page 69 fig 10.4
Monsoons in India destroyed onion crops leading to a
decrease in supply- also known as a shortage.
When you have shortage we need to raise the price to
get back to equilibrium.
 One showing the demand and supply curve for the
price of tomatoes.
an increase in demand for tomatoes, due to an increase in
incomes, leads to a shortage so price must increase to
reach the new equilibrium

Shortage: comes from a decrease in supply or an increase

in demand- rise in price

Surplus> comes from an increase in supply or a decrease

in demand- we need to lower the price

b. The market responded to both situations by raising the

price.

The importance of competition and incentives

one of the benefits of a market economy is choice.

Consumers are sovereign.
A choice creates competition which puts pressure on firms
to make good quality products at a lower price.
Firms compete for consumers to survive. The more
successful a firm is in keeping its costs low and the more it
targets the desires of consumers, the more efficient it is
said to be.

Firms have the incentive to create a competitive product

because of profit.
A market economy is an economy based on the private
sector

Market economic system has rewards: “carrots” (profits)

and punishments “sticks” (going out of business)

The rewards are profits and the punishment is going out of

business.

It’s important for entrepreneurs to respond to consumer

demand, innovate and expand.

In labour markets, workers can enjoy higher wage if they

have the right skills and are efficient. Workers who lack
skills and lack occupational and geographical mobility will
have low incomes.

Individual Activity 2

a. Higher wages
b.
Decrease in Supply (curve shifts to the left) and an
increase in Wages (so instead of writing P, you write a
W). A decrease in supply always means shortage.
 page 155 Fig 18.6

Private and Public sectors:

Private Sector: covers business organizations which are

owned by shareholders and individuals.
Their goal is profit. They are more efficient and have a
better quality price than public goods and services.

State Owned Enterprises (SOE’s): organizations owned

by the government which sell products or services.
Public Sector: the part of the economy controlled by the
government.
Their goal is welfare of the people. Their prices are
affordable and they make sure everyone (including the
poor) can afford basic necessities: healthcare, education,
food.

13.2 Advantages of a Market Economic System

What Is a Market Economy? Private sector

The assumption behind a market economy is that supply and demand are
the best determinants for an economy's growth and health. These market
forces (price mechanism) influence what goods should be produced, how
many goods should be produced, and at what price the goods should be sold.
These factors determine other economic decisions, such as how many
individuals companies should employ. The advantages of a market economy
include increased efficiency, productivity, and innovation.

1. A market economy should be very responsive to

changes in consumer demand. Consumers are
sovereign-they determine what is produced.
 2. Resources should change automatically and quickly to
reflect changes in consumer demand. This is for 3
reasons:
a. The price mechanism (the system by which the
market forces of demand and supply determine
price) in a market economic system provides
information on which products are increasing in
demand.

EXAMPLES of the price mechanism:

1. excess demand leads to a shortage so we
need to raise the price to go back to
equilibrium (goal of price mechanism)
2. excess supply leads to a surplus so we
need to lower the price to go back to
equilibrium.
GOAL: to have price = quantity demanded or
supplied= equilibrium price

b. a market economy provides an incentive for

resources to move in response to consumer
demand as it leads to profit. Benefits firms,
workers, capital and land.
c. a market economy punishes those firms,
workers, capital and land who do not respond to
changes in consumer demand -leading to loss of
jobs and closing of firms.
3. A Market Economy gives consumers a choice, they can
decide what to buy and which firms to buy from. Firms can
decide what to produce (responding to consumer demand)
and workers can decide who to work for.

4. Costs and prices may be low. Firms will want to set

competitive prices so they can earn more profit. They will
do this by using resources to make costs of production as
low as possible. This is an example of efficiency and
reward.

5. Quality may be high. Market forces can promote the

improvement of methods of production and a rise in quality
of the products it makes. Consumer demand puts
competitive pressure on firms to provide high quality.
Tha Market Economy is all about good price quality ratio

13.3 The disadvantages of a market economy

There is a risk that the market forces of demand and supply

may not work well. In fact market failure may occur:
Market Failure: market forces (demand and supply
interaction) resulting in an inefficient allocation of resources.

1. Consumers and private sector firms may only take into

account the costs and benefits to themselves. These
are called Private Costs and Benefits. They do not
take into account the costs and benefits of others.
EXAMPLE: Some people may smoke even if it annoys
and endangers the health of those around them. This
is called an External Cost.
2. Lack of competition leading to a possible monopoly:
leading to high prices and low quality.
 3. Unable to respond to consumer demand because of
lack of workers with the right skills or geographical
immobility.
4. Firms will not make products unless they can charge
for them. Some products like military defence, which
most people want, will not be provided by a private
sector because of free -riders: someone who
consumes a good or service without paying for it.
5. Advertising can distort consumer choice persuading
people to buy products they do not want. Consumers
and producers may also lack information and make
inefficient choices
6. Uneven distribution of income with some people very
rich and some people very poor. The sick and disabled
may find it difficult to earn incomes.
7. Differences in Income will increase over time. People
earning higher incomes can save. Poor people are
unable to save. Children of the rich have more
opportunities than children of the poor.

Group Activity 2

a Those people whose labour skills are in high demand are

well paid. Entrepreneurs, who produce what consumers
want, can make high profits. Those with high incomes can
save and earn income from their savings.

b The sick, disabled and old will find it hard to earn an

income.
13. 4 Allocative Efficiency

allocative efficiency: when resources are allocated to

produce the right products and the right quantities.
When supply matches consumer demand

diagram a: equilibrium price and allocative efficiency

diagram b: shortage, under-production

diagram c: surplus, over- production

Market forces, by changing price, should eliminate shortage

and surpluses.
With a shortage we need to raise the price
With a surplus we need to lower the price

When there is lack of efficiency there is the threat of

punishment in a market economy and therefore a firm can
go out of business.

Individual Activity 3

a. A fall in demand would be likely to lower the price.

b. The evidence is that resources moved out of the crisps

industry, in response to a decrease in demand.
13. 5 Productive Efficiency

productive efficiency: when products are produced at the

lowest possible cost and making full use of resources.

Fig 13.3 shows letter B as productively inefficient

Letter A is productively efficient

Any of the 4 factors of production not being used

efficiently leads to point B: Example: workers lying idle on
the job, broken machinery (capital), empty factory space not
being used. Agricultural land not being used (land)

13.6 Dynamic Efficiency

Dynamic Efficiency arises when resources are used

efficiently, over a period of time as a result of investment
and innovation.
Money spent on Research and Development allows firms to
innovate products and gain higher margins.

Group Activity 3

a. Bata responded to consumer demand by also making

purse
b. Higher profits mean they can increase their supply to
respond to an increase in demand. Consumers also
benefit from the company offering innovative products
 (dynamic efficiency) . Example: Covid vaccine. Thanks
to high profits, pharmaceutical companies now have
innovative products like the Covid vaccine.
13.7 Examples of the different economic systems

To a certain extent all economies are mixed economies.

This is because there is some government intervention in
all economies and some private sector production.

Examples of a more market economy: USA. Public sector

exists but most land and capital are privately owned.
Sweden is an example of a country where public and
private sectors are equal in size.
North Korea is a planned economy with little land privatelt
owned

Change in economic systems

Economies can change over time

Example: Eastern Europe and Russia changed from

communism to mixed economies in the 1990’s with SOE’s
being privatised

Privatisation : sale of public sector assets to private sector

Four Part Question

a. Private sector has individuals and shareholders

deciding how to allocate resources. Public sector has
 the government who decides how to allocate
resources
The goal of private sector is profit. The goal of the public
sector is public sector

b. Consumers are said to be sovereign in a market

economic system as they determine what is produced.
They signal their choices by means of the price mechanism.
If they want to buy more of a product, they will bid up its
price which will encourage firms to allocate more resources
to its production. If they want to buy less of a product, the
price they are willing to pay will fall. The reduction in price
will result in fewer resources being allocated to its
production.

c. Profit plays a key role in a market economic system.

Profit is the incentive firms have to respond to the signals
that consumers send via price changes. The opportunity to
earn a profit encourages firms to produce the products
consumers are willing and able to buy, using the most
efficient methods of production. If consumers demand
more of a product, its price will be bid up. More revenue will
be earned by making the product, which may increase their
profit. If firms can cut the costs of production by, for
instance, introducing new, more productive capital
equipment, their profit will again rise. Those firms that are
the most efficient will gain the highest profits. They will
have the finance to expand, while those firms that are
inefficient and cannot make a profit may go out of business.

d. Prices may be low in a market economic system. This is

because there may be a high level of competition in such a
system and because profit plays a key role. If there are a
high number of firms competing for the custom of
consumers, they will have to keep their prices low. To make
a profit when prices are low, costs will have to be lower.
This means that firms will have to use the most efficient
methods of production, which keep cost per unit low and so
enable them to charge low prices. A market economic
system, however, does not mean that all prices will be low.
Indeed, if a market economic system is working efficiently,
the prices of products that are in high demand will be high
relative to those products that are less popular. This
difference in price will encourage more resources to be
devoted to those products that are most in demand. The
prices of the popular products may still be lower than might
exist in other types of economic systems if there is a quick
and full response to changes in market conditions.

There is, however, no guarantee that a market economic

system will always work efficiently. There may not be a high
level of competition in all markets. If one firm dominates a
market, it will have more power than consumers. It will be
able to raise the price it charges because consumers will
not be able to switch to substitutes. There are a number of
other reasons why inefficiency may occur in a market
economic system, causing prices to be high. For instance,
firms may want to respond to an increase in consumer
demand by producing more. If, however, they have difficulty
recruiting more workers due to the occupational and/or
geographical immobility of labour, they may not be able to
adjust their supply by much. Inelastic supply will mean an
increase in demand that will result in a higher rise in price
than would have been the case with elastic supply. A
market economic system has the potential to keep prices
low if there is, for instance, a high level of competition and
mobility of factors of production. In practice, this does not
always occur in all markets.