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The market mechanism is the only effective way to allocate resources. Discuss - Essay Example

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Macro & Micro economics Contents Contents 2 Introduction 3 Discussion and Analysis 3 Conclusion 8 References 9 Introduction Every economy seeks to find a solution to the basic economic problems. Since the amount of resources available to a particular economy is scarce but there is no limit to the human wants there should be a technique in which this allocation should be done…
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The market mechanism is the only effective way to allocate resources. Discuss
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Download file to see previous pages 8). This essay looks into the various aspects of the competitive market economy and analyses the fact that the resources can be allocated most efficiently if the economy operates in a competitive framework. Discussion and Analysis In a free market economy the price and the quantity of the product demanded is determined by the market forces of demand and supply. According to the theory of demand as the price of a product increases the quantity demanded for the product gets reduced. On the other hand, other things remaining constant as the price of a product decreases the demand for the product increases. The inverse relationship between the price and the demand for a commodity gives rise to a downward sloping demand curve. The supply curve for a commodity is however upward rising curve. The equilibrium price and quantity is determined by the interaction of the demand and the supply curves (Samuelson and ?Nordhaus, 2010, p. 57). This market mechanism has been explained with the help of the following diagram. Figure 1: Interaction of Demand and Supply Source: Besanko and Braeutigam, 2010, p. 36 In the figure it is seen that the initial demand curve id D1 and the initial supply curve is S. Now the market will reach equilibrium at the point A where the quantity demanded for the product would match the quantity supplied. At this point the quantity demanded would be Q1 and the quantity supplied would also be Q1. The price at which the market equilibrium would be reached is P1. This price is neither determined by the buyers or the sellers but the combined forces of the demand and supply existing in the market. Now suppose the market demand for the product increases from D1 to D2, with the same level of market supply the price of the product will increase to P1 and the quantity demanded of the product would increase from Q1 to Q2. Hence the new market equilibrium would be changed to B. At the point B the quantity demanded would match the market supply. The demand curve would shift to the right due to a variety of reasons. When the income of the individuals increase the disposable income of the people would increase and it would lead to a rise in the demand for a particular product. Similarly the supply of products may also decrease due to a variety of reasons. When the price of the raw materials increases the firms are not able to supply the product at the same cost. Thus the supply decreases. As a result the equilibrium price and quantity would undergo change. Figure 2: Shifts in the Supply Curve Source: Besanko and Braeutigam, 2010, p. 36 In this figure the reduction in the supply of the commodity pushes the supply curve to the left. The quantity supply reduces from Q1 to Q2 but the price increases from P1 to P2. Therefore at the same level of market demand the new equilibrium is formed at the point B. The demand and supply forces would act naturally in a free market where there are no restrictions by the government. This is true for the perfectly competitive markets where none of the buyers or the sellers has the power to control the price in the market. Therefore a competitive market is one in which there would be large number of buyers and sellers (Petri, 2004, p. 77). The sellers would have their aim to maximise the profit of ...Download file to see next pages Read More
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