Different societies have different ways of allocating scarce resources. Explain how resources are allocated in a free market economy?
Scarcity is the availability of resources in limited amounts relative to unlimited nature of human wants that the resources are meant to satisfy. According to Richard G Lipsey It is the basic economic problem that is arises because people have unlimited wants and limited resources. Because of scarcity the economic decision must be made to allocate resources efficiently. When we talk of scarcity within an economic contest, it refers to limited of resources not lack of riches. These resources are the inputs of production land, labour and capital.
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For example, a commodity in short supply but which has a high demand attached to it will have a high price. Alternatively, one which has a high supply and low demand will have a much lower price attached to it. Prices and the self-interest of people and businesses therefore act as a guide to the decisions that have to be taken. The self interest which drives suppliers to allocate resources is called the invisible hand. This invisible hand brings together private and social interests in a harmonious way: this is the fundamental philosophy underpinning the workings of the market economy.
If supply exceed demand the price will fall bringing more buyers until the price is established which equates the quantity being demanded and supplied. Price rations good services not on basis of need and wants but on the ability to pay the price. The price mechanism allocates resources to different uses of the basic consumer vote for the production of the product; infect a vote for the vote for production of a product. Under this system those with the greater purchasing power have more votes. This might be regarded as an inadequate system especially when there is greater inequality in the distribution of income. In free market economy the factor of production are owned by the private individuals or groups of individuals who own the resources. They then rent them out to the firms so that they can produce the goods and services.
Everyone is motivated by pure self interest. Consumers maximize welfare, firms maximize profits and private individuals aim to maximize rents, wages, interest and profit. Firms can sell anything they want. They report to the consumers who are allowed to buy anything that is sold by the producers. The level of competition is very high. Firms are competition desperately for customers and the consumers are competition with each other for the goods on offer.
The market system is referred to as capitalism because of the extensive private ownership of capital. According to Kumar, the free market economy is governed by the relationship of sellers and buyers with regards to different products. Consumers in the market determine the products that a market economy produces. When people lack the ability and willingness to purchase an item, producers of that item will not produce it, because there is no demand for it.
A free market economy is characterized by private ownership of capital and control of economic resources and...