Business Environment and Investment Climate - Coursework Example

Why do some people believe that the market system is the best mechanism for allocating scarce resources and thereby encouraging a positive “investment climate”?

There should be buyers and sellers who either buy or sell the goods at an agreed price. Fourth, there should be money that is used as the medium of exchange. And fifth, based on the prices and the numbers of buyers of those goods, sellers can decide how many of the goods to produce; at the same time, based on the prices and the number of sellers, buyers can also decide how, whether, and how much to buy.

Since goods are bought and sold in the market, depending on the price, quantities, and numbers of buyers and sellers, the market system is seen by many as the best mechanism for allocating scarce resources and thereby encouraging a positive investment climate.

There are other alternatives to a market system that human societies have tried in the past and which turned out worse in the long run in several respects, such as allocating scarce resources or fully satisfying the needs of the people.

One alternative that failed is the market in a command-and-control economy that existed in communist countries until the early 1990s, where the government bureaucracy determined the types, prices, and quantities to be sold. The government commanded companies to produce what it thought the market would buy. This worked for a time, but in the long run, the goods turned out to be of poor quality, and the people tired of consuming the same items (food, cars, television sets, or clothes).

Producers were not motivated to improve the quality of their goods, because they did not enjoy marginal benefits from doing so since the government dictated the price, and therefore the profits that could be earned. Without such incentives, productivity collapsed.

When these economies were closed, the government allocated scarce resources depending on what they thought the market wanted. It turned out that instead of putting resources to best use, these were being wasted as resources were used to produce goods the market did not want to buy.

In a market system that is “relatively” free, where buyers and sellers dictate the price and quantity of each good bought or sold, each party has an incentive to get the best value. Buyers want to pay as low as possible, whilst sellers want to get the highest profit for their goods. Each tries to beat the market.

Millions of goods bought and sold means there are millions of pricing and quantity decisions made by buyers and sellers. This is the so-called market mechanism, an “invisible hand” that guides decision-making freely so that scarce resources are eventually utilized efficiently. In the market system, the prices and quantities of goods bought and sold reach a point of equilibrium where just enough goods are bought and sold at a certain price, and when prices or quantities change, the supply and demand of goods change with it.