Thursday, April 26, 2012

Free market economics overview

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Free market economy


Def An economy where all economic decisions are taken by individual households and firms and with no government intervention. E.g. USA, Hong Kong, UK.


A free market economy functions on the assumptions that firms seek greater profits, workers seek greater wages, and consumers seek best value for money. There are minimal government restrictions and intervention, as the economy regulates itself by the laws of supply and demand.


Price mechanism (def the system in a market economy whereby changes in price in response to changes in demand and supply have the effect of making demand = supply)


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Shortage If demand increases or supply decreases, d s. Producers will raise their prices, and supply more. Because of the higher prices, some consumers will be discouraged, and demand will fall. Since demand falls and supply increases, the shortage is eliminated.


Surplus If demand decreases or supply increases, s d. Prices will drop. Producers will now supply less because of the disincentive to produce, and consumers will demand more, since prices are lower. Demand increases and supply decreases, and the surplus is eliminated.


Similarly in the factor economy, as demand for the good increases/decreases, the demand for factors of production of that good also increases/decreases, and prices rise/fall until supply meets demand.


This price mechanism is extremely important in regulating a free market economy, and keeping efficiency at its highest.


Advantages


• Functions automatically, there is no need for the government to make economic decisions.


• Maximizes efficiency in an economy. The more efficiently firms utilize the factors of production, the higher their profits will be. Workers work better to get better wages and job security. Consumers buy the best products at least prices, this gives an incentive to firms to produce better goods and services at lower prices. Everybody gets what they want.


• Competition between firms for higher sales keeps prices low, leading to greater value for money for the common man.


Disadvantages


• Monopoly. Certain large firms, once they gain control, dominate a market, leading to increasing prices and lower efficiency.


• Periods of macroeconomic instability (recession, inflation) are caused because of the interlinking of various industries.


• Unequal distribution of power and property.


• Certain necessary non-profit goods and services may not be produced


• In the pursuit of profit, industries may take unethical shortcuts, leading to environmental degradation.





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