Demand & Supply Analysis and Choice of Economic System - Essay Example

? Question Even though the free market economy functions automatically, explain why in practice most countries adopted some form of the mixed economy in allocating resources. Free Market Economy A free market economy is a market system where transactions between buyers and sellers are determined only by mutual consent. This excludes that one party gets the deal by duress or deception; it also excludes the intervention of a third party – like government – to force or prevent the market. A free market limits government intervention in the application property rights, contract enforcement and verification of consent (Grossman, 2005). The market economy means an economic system where decisions of production, exchange and allocation of goods and services is mainly determined using information derived from the free interaction of supply and demand established by market forces.  Limitations of Market Economic System There are several limitations of market economic system to be implemented in economy. The following are the key shortcomings of a market economic system: Imbalances in Bargaining Power A free market can occasionally result in formation of monopoly, duopoly, oligopoly or a cartel. Such structures create dominance of suppliers in the particular market to the disadvantage of buyers. For this reason, free market economy can potentially impinge on the rights of a certain segment in the economy. A fair exchange implies a relationship of equality between the persons concerned, which is absent in these scenarios. Sometimes, in a market economy the employer and the employee are not in a relationship of equality. The employer can attempt to dictate terms to the employees, therefore, a safeguarding body is required to ensure payment of minimum wages and to enforce health & safety measures. Provision of Public Goods A free market economy cannot provide provision of pubic goods whose benefits are distributed over a very large population and cannot be directly traced. For instance, roads and national defense cannot be provided by a private enterprise. Therefore, some intervention is needed in the market economic system for these provisions (Grossman, 2005). Provisions for Safety Net A free market economy cannot provide social security to the citizens of the country. A market economic system cannot find mechanism to transfer funds from have’s to havenot’s and to help citizens in the lower income groups to rise from the vicious cycle of lower economic strata. State invention is essential for redistribution of wealth and income for functioning of a healthy society. Mixed Economic System A mixed economy is an economic system in which many private companies and a strong public sector coexist. In other words it is a mixture of ideas of the market economy and planned economy. The reason some form of a mixed economic system in in place in almost all countries of the world is that mixed economic system fulfills the above mentioned shortcomings of a free market economy. A government can promote free enterprise while reserving certain areas of the economy through nationalization , or then it privatize all enterprises while creating a legal framework which limits actions which impinges on the rights of certain segment of the economy. Most countries today have a mixed economic system to a certain level. Question 2 – Demand & Supply Changes in Metal and Automobile Markets 2.1 - Impact on the Prices of Palladium Metal following Usage of Replacement Metals it is found that the alternative metals will replace palladium in the process of production of an automobile. This implies a leftward shift in the aggregate demand curve for palladium metal because less palladium will be demanded at each price level. This shift is depicted in the graph below by the movement of demand curve from D1 to D2. Since, the supply of palladium is dependent on the rate at which the metal is extracted from the ores, there is not change in the aggregate supply of the metal (Grossman, 2005). The aggregate supply curve of the metal stays as S1. D2 D1 P1 S1 P2 As the diagram depicts, the equilibrium quantity demanded and price of palladium changes due to the change in intersection points of the demand and supply curves. The two curves now intersect at a point which corresponds to lesser quantity demanded and lower price of the commodity in the markets. The fall in the prices of palladium will not only take place in the long-term, rather an immediate fall in the prices of Palladium will ensue in the commodity markets after the news of alternate material usage does public (Baumol and Blinder, 2011). The change will be spurred by the fact that suppliers and hoarders of palladium will sense that the news will cause a decrease in the prices of palladium. Therefore, they will start selling their stock of palladium metal in the market to get rid of a commodity which is likely to decrease in value in future. This act of selling will increase the supply of palladium metal in the market, which will lead to a decrease in the price. The relative value of the fall in price depends on the percentage consumption of palladium of the total market by Mazda and Nissan. Perhaps, other automobile manufacturers like Ford and General Motors may continue to use palladium and platinum as automobile converters and account for a substantial share of the total market. In such circumstances, the price of palladium may not fall by a significant margin, since the movement in demand curve may represent a very small percentage of the total amount (Halm, 2003). Therefore, the net impact on the price fall may not be much. The quantity of palladium consumed in the market will fall because Mazda would shift to alternative metals for production of converter. 2.2 - Impact on the Markets for Mazda and Nissan following the Implementation of New Technology The implementation of new technology will reduce the cost of production of automobiles made by Mazda and Nissan. This is because alternative metals cost lesser than current prices of palladium. These metals represent a variable cost in the manufacturing process. When the variable cost of production of Mazda and Nissan falls, this results in an increase in cost of production for Mazda at each price level (Baumol and Blinder, 2011). Conversely, the inclination of Mazda and Nissan to supply a given number of automobiles in the market will be higher due to lower average cost per unit of automobile produced, because the cost of production associated with every production level is lower. Graphically, this change in inclination of the suppliers to provide an automobile at each price level is represented by a rightward shift in the supply curve from S1 to S2. Shift from S1 to S2 will change the intersection point of the aggregate supply curve with the aggregate demand curve of the automobile. The new intersection between the two curves corresponds to an intersection point which corresponds to a lower price P2 as compared to original price P1 of automobiles. The new equilibrium price is lower than the previous equilibrium price, which entails that the price of automobiles produced by Mazda and Nissan falls. s1 D s2 P1 P2 The most important shift takes place in the quantity demanded. According to the new equilibrium point, the quantity of automobiles made by Nissan and Mazda increases because at lower price level greater number of customers are willing to purchase the product (Baumol and Blinder, 2011). The relative movements of the price and quantity are dependent on the elasticity of the demand curve. It is anticipated that the new price level will cause an increase in the total revenue earned by the company and the net outcome of investment in Research and Development will be beneficial for Nissan and Mazda (Halm, 2003). A displacement effect is anticipated in the market, whereby, competitors which produce automobiles for the same market will observe a net decrease in the demand of their automobiles, because consumers will shift to a lower priced alternative of automobiles that uses alternate metals as the convertor rather than expensive palladium. 2.3 - Likely Consequences of Non-Adoption of New Technologies in the Automobile Industry is that the respective firm will lose competitiveness in the consumer markets. The one key advantage of investment in R&D and adoption of new technology for a firm is to gain a temporary monopolistic power or a reduction is cost of manufacturing. The above mentioned example of innovation in automobile industry is associated with a decrease in cost of manufacture since a lower priced metal is used in place of an expensive. Absence of such adoptions of technology will entail that the firm will lag behind its competitors and will lose market share in the long-run. References Baumol, W. and Blinder, A. (2011) Economics: Principles and Policy, Ohio: Engage Learning. Grossman, G. (2005) Economic systems, Ohio: Prentice Hall. Halm, G. (2003) Economic systems: a comparative analysis, New Jersey: Holt, Rinehart and Winston. Read More