Cambridge As Level Economics Past Paper Solved

Question

With the use of the diagram, explain how prices allocate scare resources in a market economy (8)

Answer

A market economy means all economic resources such as land, material, and capital are privately owned. All economic decisions are taken by individual consumers and firms with the act of their own self-interest. For example, firms seek to maximize profits, consumers are motivated by the desire of maximizing their utility and laborers seek a maximum wage.

In a market economy, the price mechanism is operated by the market forces of demand and supply of goods and services without government intervention. The price mechanism influences the millions of decisions to allocate the resources. As a result, firms or individuals are always competitive use of all their resources to get maximum benefits. And they try affording to use all resources efficiently to do it far better.    

Resources allocation is one of the most important functions of the price mechanism. It means that market prices will adjust to demonstrate where resources are required and where they are not. Price fluctuation reflects the use of resources.

A change of consumer choice results in a fall in demand from D to D1 and decrease the price level in the market. Falling demand occurs due to the change in consumer behavior in a short period. The impact is shown in the diagram. On the other hand, in a long period, firms will leave the industries and start to other new industries with new ideas and innovation. Meanwhile, consumers will have increased their spending on other new products. Firms will also employ more resources to produce higher products to boost supply in the market. Thus, higher demand in the market will lead to higher prices of goods and services.    If market prices are rising due to higher demand from consumers it will be a signal to suppliers to expand the resources to produce more products or commodities to meet current market demand.

Finally, the price mechanism in the market economy allocates or reallocates all resources according to consumers’ choices.

To know more details click : https://www.youtube.com/watch?v=bCQDtu5813Q&t=42s

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