1.2 The allocation of resources

• incentives on economic agents for resource allocation

  • for an entrepreneur in a firm, the incentive for taking risks is profit
  • rewards are positive incentives which will make the consumers better off
  • where incentives are not given properly, resources will be misallocated
  • firms need an incentive to engage in risk taking so that they innovate
• market economy

  where governments leave markets to their own devices
• advantages of market economy

  • firms are likely to be efficient because they have to provide goods and services demanded by consumers
  • the bureaucracy from government intervention is avoided
  • some economists might argue the freedom gained from having a free economy leads to more personal freedom
• disadvantages of a market economy

  • the free market ignores inequality
  • there could be monopolies, which could exploit the market by charging higher prices
  • there could be overconsumption of demerit goods which have negative externalities such as tobacco
  • public goods are not provided in a free market such as education
• Planned economy

  Where the government allocates all of the scarce resources in an economy to where they think there is a greater need
• advantages of planned economy

  • it might be easier to coordinate resources in time of crises, such as wars
  • the government can compensate for market failure, by reallocating resources
  • inequality in society could be reduced
  • the abuse of monopoly power could be prevented
• disadvantages of planned economy

  • governments fail
  • they may not necessarily meet consumer preferences
  • it limits democracy and personal freedom
• mixed economy

  this has features of both planned and market economies
• productive efficiency

  occurs when resources are used to give the maximum possible output at the lowest possible cost
• allocative efficiency

  occurs when resources are allocated to the best interests of society