ECO - 2.2 Resource allocation

• The Central Economic Problem

  • Wants are unlimited/infinite but resources are limited/ finite/ scarce
  • A choice has to be made
  • Involve OPPORTUNITY COST
• 3 basic questions


  • What & how much to produce?
  • For whom to produce?
  • How to produce?

  
• Problem of Resource Allocation

  • What goods and services to make and sell?
  • How to make the goods & services?
  • Who is to receive the goods and services that has been produced?
• Types of Economic Systems

  • Planned Economy (Centrally Planned/ Command/ Socialist)
  • Market/ Free market Economy (Free Enterprise/ Capitalist/ Private Enterprise/ Laissez-Faire)
  • Mixed Economy

  
• Planned Economy


  • All decisions are made by the gov
  • Resources are state-owned (controlled by & accountable to the gov), & are allocated based on gov directives
• Market Economy


  • All decisions are made by the private sector - consumers dictate what is to be produced & firms respond
  • Resources are privately owned & allocated by the price mechanism
  • There is no government intervention
• Mixed Economy


  • Combines market system + some gov planning & control
  • Both private & public sectors play a role in decision-making & ownership of resources
• The Market System


  • All economic decisions are made by the private sector firms & individuals
  • All resources are privately owned
  • Everyone is assumed to be motivated by self-interest
• Consumers in the Market System

  Aim to maximise satisfaction (or utility)
• Producers in the Market System

  Aim to maximise profit
• Price Mechanism


  Scarce resources are allocated through the price mechanism
• How the Market System Determines Resource Allocation

  1. What to produce?

  2. How to produce?

  3. For whom to produce?
• Increase in demand for product A


  • Push up the price of product A
  • Act as a 'signal' to producers
  • Product A becomes more profitable
  • Firms are attracted to produce more of product A
• Decrease in demand for product A

  • The market price of product A will fall
  • Product A becomes less profitable
  • Firms will start producing fewer product A
  • Firms will re-allocate their resources to produce other products
• The market prices of the different products act as a signal that guides producers on what to produce
• Producers will look at the amount they have to pay for each factor of production (wages, rent, etc) to determine the cheapest method of production
• The price determines who is able to get the good