The Free Market Economy Issues - Essay Example

?Microeconomics Microeconomics Answer The free market economy is an economic structure in which the forces of the market interact with one another in order to determine the equilibrium market condition. The main forces of the market are the forces of demand and supply. The interaction between these two forces develops the price mechanism in a free market economy. The price mechanism refers to the method interaction occurs between the decision of buyers (consumers that make consumption choices) and sellers (businesses that take decision about allocation of scarce resources among different productive uses). The theory of “invisible hand” proposed by the father of economics, Adam Smith, refers to this theory of price. According to Smith, prices are the sacrifice made by customers in order to make a utility gain through consumption of the good or service and the gain made by producers by selling the product that they have produced. Therefore, any rational consumer would be willing to make lesser sacrifice for a comparatively larger amount of gain. On the other hand, producers or sellers would desire to be willing to earn more by selling their product than the sacrifice they have made during producing the good. The market comes to equilibrium at the point at which both the decisions regarding buying and selling the good intersect with one another. This phenomenon is termed as the invisible hand, since the market operates without intervention by any third party (Mankiw 26). Figure: Free market equilibrium (Source: Author’s creation) Three important functions are played by price mechanism in a competitive market economy. These are signaling function, rationalling function and incentive function. Signaling function Prices of goods and services in a competitive market economy demonstrate the rate of availability or scarcity of resources in the market. It indicates whether resource is allocated adequately in different sectors in the economy (Adil 71). In the long run, high price level signals producers to enter the market, while customers are signaled to leave the market and look for cheaper substitutes. Therefore, supply rise and demand falls. Figure: Signaling effect (Source: Author’s creation) Rationalling function Prices can ration scarce resources when market demand is much higher than market supply. If market demand is higher, price would rise, thereby making the good available to those customers only that have the demand for the good backed by purchasing power. It helps to bring the market to equilibrium from a position of disequilibrium by equaling demand with supply (Boyes and ?Michael 26). Incentive function Price mechanism plays an active and important role in the market economy. Price of a good is the incentive for both buyer and seller to buy or sell the product. For successful running of a competitive market, prices should be efficient enough to incentive the economic agents to involve into economic transactions. Figure: Rationing and incentive effect (Source: Author’s creation) If there is excess demand it raises price. Incentive effect allows suppliers to increase supply while rationalling effect makes buyers to reduce demand. This leads to a new equilibrium (from e to e2). Answer 2: Demand and supply are two basic forces that operate in a competitive market structure. Price plays an important role in determining the equilibrium quantity of demand and supply in this type of economy. Although economic theory simplistically states that there is negative relationship between price of a product and its demand and positive relationship between price of the product and its supply; there is a difference between expansion and increase in demand or supply for a good or service and contraction or decrease in demand or supply for a good or service (Friedman 13). Expansion or contraction in demand or supply Demand (or supply) can change either due to change in price of the good (or service) or due to change in other variables affecting price. When there is a change in the price, other things remaining constant, then demand (or supply) moves along the curve. If, with fall in price, demand moves downwards along the curve, demand expands. With rise in price, demand moves upwards along the curve, i.e., demand contracts. In case of supply the case is the mirror opposite (Henderson 39). The following diagram shows the extension and contraction of demand and supply curves. Figure: Extension and contraction of demand and supply Demand Supply (Source: Author’s creation) If price rises, supply moves upwards along the supply curve, which implies supply expands. Again, if price falls, supply moves downward along the supply curve, which indicates that supply contracts. Increase or decrease in demand or supply Increase or decrease in demand or supply refers to a phenomenon in which price of the good or service remains unchanged, but, other factors affecting demand changes. These factors are prices of related (complementary or supplementary) goods, prices of taste and preferences of customers, change in income of the consumer, government taxes or subsidies, advertisements and social awareness. When any of these factors change, price remaining unchanged, the demand (or supply) curve would shift to express a change in demand (or supply). If the demand (or supply) curve shifts rightward or outward it indicates that quantity of demand (or supply) of a good or service has increased at the same price. If the demand (or supply) curve shifts leftward or inward it indicates that demand (or supply) has decreased at the same price. The following diagram illustrates the increase and decrease in demand and supply. Figure: Increase and decrease in demand and supply Demand Supply (Source: Author’s creation) Answer 3 (a): The change in demand for a product with respect to price or other attributes occurs depending on the kind of the concerned product. In this case, the good is mobile smart phone. Smart phones belong to the category of luxury goods. Luxury good is a type of normal good. Hence, the demand for luxury good is positively related to change in income of the consumers. When the wage rate of the workers assembling smart phones is increased, with price remaining unchanged, real wage rises. If real wage rises, it would indicate that the level of disposable income in the hands of the workers rises. Therefore, the demand for smart phones would rise (Jain and Sandhu 19). The market for mobile smart phones as a whole in the United Kingdom would reflect a rise in demand for mobile smart phones. This is a case of incase in demand. 3 (b): Income tax is the amount of money that an individual with some source of income has to pay to the government on the basis of the money earned annually. There are specific tax slabs that are applied to the people of different income ranges. Income taxes are deducted from the total income of the earner to get the disposable income. An individual can use this disposable income to make expenditure on the purchase of various goods. In case of normal goods, if disposable income rises, demand for normal good also rises. If the tax rate is reduced, total disposable income rises. Hence, if the government of United Kingdom reduces all income tax rates, demand for mobile smart phones in the UK market would rise. This is a case of increase in demand. 3 (c): Demand for luxury goods also depends on the traditional background of the consumers, culture of the society, evolution in the tastes and preferences of the consumers as well as rising social awareness. Luxury goods are such goods that are expected to improve living standards of the population that uses it and also make their daily lives easier than before. Therefore, it has to be taken into consideration that the demand for luxury goods change on the basis of perception of consumers regarding the short term effect of the good on their lives. Smart phones are the outcome of modern technological developments. These devices ease out several activities in the daily lives of the user. Besides, the user intends to keep himself or herself updated with the modern technological developments. On the other hand, people are becoming more conscious about the goods they use with regard to their effects on their own health and the environment. Therefore, it shows that the publication of a new report emphasizing on the long term damaging effects of electromagnetic radiation from the use of smart phones would draw mixed reaction from the consumers. Some consumer would make their purchasing decision on the basis of the short term benefits received from the use of smart phones. They would not reduce their demand for the product. On the other hand, some consumers, who are conscious about the health condition of themselves and other consumers in the society, would undergo a change in their preferences. It is expected that they would reduce demand for mobile smart phones. The net result, whether the demand falls or remains unchanged or rises, depends on the intensity of demand of these two groups of consumers (Lindeman 46). 3 (d): Quota is one of the policies adopted by the domestic government in which it can regulate the import demand for foreign goods. Imposition of quota is a process of implementing quantitative restriction on import demand by a country. According to the diagram, quantity demand before implementation of quota restriction was Qd and quantity supplied domestically was Qs; import was AB. After implementation of quota restriction, the government specifically mentions the amount of import of smart phones manufactured and sold by the countries in South-east Asia certain goods, beyond which the country’s importers cannot import within a given period of time. Since domestic demand is greater than this amount, in the short run prices would rise (Moon 38). This is because shortage is created in the UK market. With rise in price, demand would gradually decline from Qd to Qd1 but domestic supply would rise from Qs to Qs1. Therefore, difference between domestic demand and supply would fall and amount of import falls from AB to CD. Figure: Import quota restrictions (Source: Author’s creation) 3 (e): Marketing campaigns are made to make a new product well known among the target customers in a market or to improve the performance of an existing product. 4G technology is the result of a modern development of internet facility. It is faster than the old 3G technology and can be accessed through devices that are compatible with the technology. Modern mobile smart phones are developed on modern operating systems and offer the most updated facilities to its users. If a well researcher marketing campaign is launched about the benefits that might be gained by smart phone users on introduction of 4G technology in the UK, it would persuade the target customers to increase their demand for the good. If marketing is made regarding any of the attribute of a particular product, demand for the product as a whole rises (Taylor and Weerapana 19). In this case, marketing is made regarding the benefits of 4G technology on smart phone users and the demand for smart phones rise. This is a situation of increase in demand. Figure: Shift in demand curve (Source: Author’s creation) 3 (f): With advancement of technology, manufacturers need to update their production units by replacing the old techniques of production with new ones. Smart phone manufacturers might introduce more efficient machines in the production of smart phones. Efficiency is measured by the extent to which the level of output rises with the use of same amount of resources as before or by using lesser amount of resources. If more efficient machines are installed, this implies that the level o output would rise with the use of same or lesser amount of inputs. This would lead to reduction of cost of production or earning of proportionately higher amount of revenue (Lambert 52). Since cost of production falls, producers would be able to sell their products at lower prices. As price of the good falls (from P1 to P2 in the following diagram), demand for the good rises (from Q1 to Q2). Thus, demand for mobile smart phones in the UK market would rise. This case represents a movement along the curve and is a situation of extension of demand. Figure: Demand for smart phones after fall in price (Source: Author’s creation) Works cited Adil, Janeen R. Supply and Demand. Minnesota: Capstone, 2006. Print. Boyes, William J. and ?Michael Melvin. Fundamentals of Economics. Massachusetts: Houghton Mifflin, 2008. Print. Friedman, Milton. Price theory. New Jersey: Transaction Publishers, 2009. Print. Henderson, Hubert D. Supply And Demand. London: Kessinger Publishing, 2004. Print. Jain, T. R. and Sandhu, A. S., 2007. Macroeconomics. New Delhi: FK Publications. Lambert, Douglas M. Supply Chain Management: Processes, Partnerships, Performance. Florida: Supply Chain Management Inst, 2008. Print. Lindeman, J. Bruce. EZ-101 Microeconomics. Little Rock: Barron's Educational Series, 2002. Print. Mankiw, Gregory. Principles of macroeconomics. Connecticut: Cengage Learning, 2009. Print. Moon, Mark A. Demand and Supply Integration: The Key to World-Class Demand Forecasting. California: FT Press, 2013. Print. Taylor, John B. and Weerapana, Akila. Economics. Connecticut: Cengage Learning, 2008. Print. Read More