1.8.1 How markets and prices allocate resources - PowerPoint Presentation

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1.8.1 How markets and prices allocate resources

AQA 1.8: The market mechanism, market failure and government intervention in markets

Recap year 1:

What is meant by the price mechanism?

What is meant by market failure?

What is meant by government intervention?Slide2

1.8.1 How markets and prices

allocate resourcesThe rationing, incentive and signalling functions of prices in allocating resources and coordinating the decisions of buyers and sellers in a market economyThe advantages and disadvantages of the price mechanism and of extending its use into new areas of activity Students should understand how economic incentives influence what, how and for whom goods and services are producedStudents should be able to assess the view that the price mechanism is an impersonal method of allocating resourcesThey should also be able to assess the view that introducing the price mechanism and markets into some fields of human activity may be undesirable and is likely to affect the nature of the activity, e.g. introducing a market for blood changes the nature of the transaction and the incentives involvedRecap from Y1 EconomicsSlide3

Advantages of the price

mechanismThe price mechanism gives an indication to firms of what goods and services to supplyAdam Smith’s ‘Invisible Hand’ tells consumers what the price of products is and allows for consumer sovereignty where producers have to take into account their wants and needsThis means that producers will supply what is desired by consumers at any given price at a point in timeThis will provide for allocative efficiencySlide4

Advantages of the price mechanism

Firms will follow trends in different markets in order to decide what to produce in the futureIf demand increases resources will be reallocated to that product and vice versa. The market mechanism determines thisAs some markets die others grow meaning that firms are constantly using market research to inform them regarding production decisionsIf a market shows potential for growth a firm might reallocate its resources to maximise profits in the futureAs markets are competitive firms will strive to lower costs, leading to productive efficiencySlide5

Disadvantages of the price mechanism

The price mechanism is an impersonal method of allocating resources as it creates inequality. Those with income benefit from accessing resourcesThe production of public goods, which benefit society, are ignored by private firmsInformation asymmetry and monopoly power lead to consumers being exploited by firmsAs firms look to add value high priced luxury goods might be produced at the expense of necessities, leading to a misallocation of resourcesSlide6

Disadvantages of the price mechanism

The price mechanism is, at times, brutalFirms that cannot adapt as trends in the market change will go out of businessThis leads to unemployment which impacts heavily on society, particularly if there is structural changeAs firms vie for the same resources there is duplication and inflationary pressure as demand bids up the price of these resourcesSlide7

The undesirability of introducing the

price mechanismIntroducing the price mechanism and markets into some fields of human activity may be undesirableWhen there is an immobility of factors of production e.g. land or labour, this can cause shortages and inflationary pressureThis might be undesirable as it creates social costs with members of society missing out as they cannot afford certain products e.g. health care and educationThis impacts on society as a whole as not all citizens feel that they belong. Social tension is createdFirms would not have a pool of workers with the required human capital to perform certain jobs. This would lead to less quality and therefore less demand. This would impact adversely on economic growthGovernment bodies are leaders in research and development and invest heavily in private firms through grants, guaranteed loans etc.Without government investment where would your iPhone be?Slide8

The undesirability of introducing the

price mechanismThe price mechanism might reduce the number of merit goods available to society whilst increasing the number of demerit goodsEducation, health care etc. are likely to be underprovided as families could not afford them. This could lead to long term social costs as an uneducated and poor health economy is createdFirms might increase the supply of demerit goods such as drugs, alcohol and cigarettes if left to meet the demands of the market without government interventionSlide9

The affect on the nature of activity

Introducing the price mechanism and markets into some fields of human activity is likely to affect the nature of the activityA market for blood would increase supply as private firms moved into the market to make profitThis would increase supply and lower price New firms will join the market and existing firms will increase supplyThis will impact on other markets. As firms increase supply in one market they might reduce supply in anotherShould we create a legal market for some drugs?Slide10

The affect on the nature of activity

Markets are dynamic There are constant changes and this impacts on the nature of economic activity on a daily basisMarkets for substitutes and complements will changeEconomic variables such as inflation and unemployment will be affected as resources are reallocatedThe whole of society is indirectly involved in these changes and the laws of demand and supply will dictate the effects as new markets e.g. for blood are created