1.2 The allocation of resources

• What does resource allocation refer to?

  It refers to how resources are distributed among producers and how goods and services are distributed among consumers.
• How do economic agents respond to incentives in resource allocation?

  Economic agents respond to incentives by allocating scarce resources to provide the highest utility to each agent.
• What is the main incentive for an entrepreneur in a firm?

  The main incentive for an entrepreneur is profit.
• What are rewards and penalties in the context of resource allocation?

  Rewards are positive incentives that make consumers better off, while penalties make them worse off.
• What happens when incentives are not given properly?

  When incentives are not given properly, resources will be misallocated.
• How do prices in market economies act as signals?


  Prices provide signals to buyers and sellers, which incentivizes them to purchase or sell goods.
• What does a high demand and high price for a good incentivize firms to do?

  It incentivizes firms to allocate more resources to producing that good.
• Why do entrepreneurs want to innovate?

  Entrepreneurs want to innovate to avoid loss and gain profit by reducing production costs and improving product quality.
• What is the role of innovation in resource allocation?

  Innovation is necessary for firms to engage in risk-taking and prevent misallocation of resources.
• What are the characteristics of market economies?

  • Also known as laissez-faire economies
  • Governments leave markets to their own devices
  • Economic decisions are made by private individuals and firms
  • Private individuals own everything with no government intervention
  • Governments usually intervene with laws and public services

  
• Who were famous free market economists?

  Adam Smith and Friedrich Hayek were famous free market economists.
• What is Adam Smith's theory of the invisible hand?

  It describes how prices are determined by the 'spending votes' of consumers and businesses in free market economies.
• What did Hayek argue about government intervention?

  Hayek argued that government intervention makes the market worse.
• What determines what to produce in a market economy?

  What to produce is determined by what the consumer prefers.
• How do producers decide how to produce goods in a market economy?

  Producers seek profits to determine how to produce goods.
• Who benefits from the goods produced in a market economy?

  Those with the greatest purchasing power in the economy benefit from the goods produced.
• What are the advantages of market economies?

  • Firms are likely to be efficient and lower average costs
  • Overall output of the economy increases
  • Bureaucracy from government intervention is avoided
  • Freedom in a free economy may lead to more personal freedom

  
• What are the disadvantages of market economies?

  • Ignores inequality and benefits the wealthy
  • No social security payments for low incomes
  • Potential for monopolies to exploit the market
  • Overconsumption of demerit goods with negative externalities
  • Public goods and merit goods are underprovided

  
• What is a planned economy?

  • Government allocates all scarce resources
  • Also referred to as central planning
  • Karl Marx viewed it as a solution to free market instability
  • Profits in free markets seen as exploitation of labor

  
• What determines what to produce in a planned economy?

  What to produce is determined by what the government prefers.
• How do governments decide how to produce goods in a planned economy?

  Governments and their employees decide how to produce goods.
• Who benefits from the goods produced in a planned economy?

  Goods are produced for whoever the government prefers.
• What are the advantages of planned economies?

  • Easier coordination of resources in crises
  • Government can compensate for market failure
  • Reduces inequality and maximizes welfare
  • Prevents abuse of monopoly power

  
• What are the disadvantages of planned economies?

  • Governments may fail and be uninformed
  • May not meet consumer preferences
  • Limits democracy and personal freedom
• What is a mixed economy?

  • Features of both planned and market economies
  • Most common economic system today
  • Different balances between command and free economies
  • Governments provide public and merit goods

  
• What determines what to produce in a mixed economy?

  What to produce is determined by both consumer and government preferences.
• How do producers decide how to produce goods in a mixed economy?

  Producers decide how to produce goods based on profits and government regulations.
• Who benefits from the goods produced in a mixed economy?

  Goods are produced for both who the government prefers and those with purchasing power.
• What is productive efficiency?

  Productive efficiency occurs when resources are used to give the maximum possible output at the lowest possible cost.
• What is the impact of productive efficiency on consumer welfare?

  Productive efficiency helps maximize consumer welfare but can be wasteful if desired goods are not produced.
• What is allocative efficiency?

  Allocative efficiency occurs when resources are allocated to the best interests of society, maximizing social welfare and utility.
• What is the relationship between allocative efficiency and affordability?

  Allocative efficiency exists when goods and services are produced that consumers want and are affordable.
• What is the condition required for productive efficiency?

  Productive efficiency occurs when firms minimize their average total costs.
• At what point does productive efficiency occur on the average cost curve?

  Productive efficiency occurs at the lowest point on the average cost curve.
• What is the relationship between the marginal cost curve and the average cost curve at productive efficiency?

  The marginal cost curve cuts the average cost curve at the lowest point, where $MC =$$AC$.
• What indicates productive efficiency on the production possibility frontier (PPF)?

  All points on the PPF curve are productively efficient.
• What is the condition for allocative efficiency?

  Allocative efficiency occurs when resources are distributed to the goods and services that consumers want, maximizing utility.
• At what point does allocative efficiency exist?

  Allocative efficiency exists at $P =$$MC$, meaning consumers pay for the value of the marginal utility they derive.
• Why are free markets considered allocatively efficient?

  Free markets are considered allocatively efficient because they produce goods and services that consumers want at affordable prices.