Roles of Profits in a Market Economy - Essay Example

Roles of Profits in a Market Economy Name Institution Course Tutor Date In a world characterized by scarce resources, it is necessary to make decisions about efficient resource allocation. The economic system in a nation plays an important role in solving problems associated with the allocation of resources. A long time ago, decisions about what is to be produced, how it will be produced and for whom were primarily determined by the governments across European and Western societies. However, a market economic system is currently preferred by these governments. Generally, a market economic system brings together consumers and producers (Myers 2012, p. 21). In a market economy, government involvement in the economy is very limited and there is widespread ownership of means of production by the private sector. Individuals are allowed to pursue their own self-interest and government only interferes to correct market failures and inequalities. Moreover, individuals are not prevented from obtaining resources, organizing those resources in the production of products for sale. Government and producers cannot put obstacles that blocks individuals and business enterprises from seeking profits through the purchase of inputs and sale of outputs. However, because of scarce resources, efficient allocation and use of resources must be carried out effectively in order to achieve profit. This essay examines the role of profits in achieving an efficient allocation and use of resources in a market economy. In modern economies, consumers have a wide range of goods and services to choose in satisfying their needs. They decide what to buy and in what quantities and firms produce products that are bought in large quantities by the consumers as illustrated in the diagram below. The quantity of products that producers supply in the market will corresponds to the consumer’s demand. In this case, the point that the supply and demand intersect in the diagram below represents optimal resource allocation. At this point, the market clears and no wastage of resources is realized. Collectively, the decisions of individuals determine the allocation of resources in an economy between different competing uses. Furthermore, distribution of outputs to the end consumers is also determined in this manner. In a pure market economy, buyers and sellers acting in unhindered markets are responsible for all these decisions. The legal structure, as well as external defense, is only provided by the state (Lipsey & Chrystal 2015, p. 17). Beyond here, all the resource allocation and distribution of income are determined by the markets. There is consensus in the field of economics that a market economy is self-organizing but what is much debated is how efficient is the result of this organization (Lipsey & Chrystal 2015, p. 17). An organized market economy behaves as if there is a power that guides it. This is because efficient order spontaneously emerges out of many independent decisions made by producers, sellers, and buyers of goods and services. Producers, sellers, and buyers all respond to the same set of prices determined in the markets, which is a reflection of the overall state of resource scarcity or plenty. In order to understand what role profits play in the achievement of efficient allocation and use of resources in a market economy, its main characteristics should be first explored. In a market economy, people respond to incentives (Lipsey & Chrystal 2015, p. 07). Buyers always look for low prices while sellers seek high prices for their goods and services assuming that others things are equal. Consumers determine what is to be produced (Myers 2012, p. 33). This occurs as a result of their spending pattern. On the other hand, the decisions of producers regarding what goods to produce are prompted by their search of profits. In essence, individuals buy and sell what they deem best for them and their families in a market economy. The majority of prices are set in open markets where different suppliers compete in an effort to sell their products to potential buyers. A legal framework that governs all the above activities in a market economy is largely a creation of the state and it also plays a large part in its administration and enforcement. This is despite the fact that the private sector owns the majority of the nation’s resources and they rearranged these resources in the pursuit of profits. The role of a market economy is the production of the most efficient use of resources as possible (Heath 2014, p. 31). This can be carried out by achieving a price level that all the markets clear. In economics, a firm achieves efficient allocation of resources at a point where the marginal cost of producing a good is equal to its price as shown in the diagram below. This is the price level that the market clears and it ensures that an efficient allocation and use resources in a market economy is achieved. In an economy, the function of firms is to compete with each other and with purchasers of products for profits and to steer prices to a level that clears the markets. Managers are required to undertake what is necessary for maximization of profits by a firm in this manner. Therefore, in a market economy, profit is a measurement of return to risk to investors. This entails the commitment of resources to a certain market or sector that brings the highest profits. As managers are required to carry out what is necessary in order to maximize profits, they will efficiently allocate and use the resources at their disposal to achieve this aim. In this case, profits act as a catalyst to the efficient use and allocation of resources in a market economy. In economics, allocative and productive efficiency of resources is given paramount importance. They are both satisfied in a market economy (Myers 2012, p. 40), in which profits play some role. Profits signal the healthiness of a market economy. The increase in profits might be a reflection of an improved supply-side of the market, that is, a higher productivity or costs have been lowered through innovation. An increase in profits can also be as a result of high demand of products and services in both the domestic and international markets. It indicates that scarce resources are efficiently allocated and used by the individuals and firms. In this case, the presence of strong profits will force firms to allocate and use resources efficiently in the economy. Nevertheless, every individual should be free to pursue their own interests if the market economy is to function effectively (Myers 2012, p. 45). This will also translate to the achievement of efficient resource allocation through the incentive of strong profits in the economy. Producers will attempt to obtain a large reward by selling their products to willing consumers for profit maximization. On the other hand, if consumers demand more of a product sold at a current market price by their willingness to pay more. In turn, profits of firms producing this product are increased. As a result, supply is expanded as resources are attracted into the industry. Firms will try as much as possible to use these resources efficiently in maximizing profits in the market. Private firms in a market economy are allowed to seek profits. The central rationale is for these firms to create competition among consumers and suppliers of goods and services (Heath 2014, p. 31). Consequently, prices are driven towards market-clearing levels by the competition. This allows the society in a market economy to generate a more efficient allocation and use of resources at its disposal. The regulatory environment and the firm’s legal structure are organized in a manner that promotes the type of competition that is likely to establish market-clearing prices. In a mature capitalist society that is characterized by a market economy, the legal structure governing corporate behavior is designed in such a way that it ensures firms seek maximization of profits through a very limited set of strategies. These strategies include those likely to result in more efficient allocation and production of resources in an economy. In other words, the economy apparatus is designed in such a way that the profits generated lead to the efficient allocation and use of goods and services. Globalization has increased the level of competition. In market economies, business firms are increasingly subjected to competitive pressures (Matutinovic 2010, p. 43). Moreover, consumers are increasingly showing distaste towards firms having business practices that misuse the scarce resources through inefficient allocation and other vices. They are not economically efficient. Economic efficiency entails efficient production and consumption (Mukherjee 2002, p. 36). Production efficiency is as a result of efficient resource allocation and efficient consumption is ensured through a distribution of desirable goods to the people. Firms are encouraged to direct its strategies towards the achievement of economic efficiency by generating profits that efficiently allocates resources. Profits acts as investment finance in a market economy. The retained profits that have been set aside by a company become its source of finance for undertaking new investment projects. In order to generate this kind of profit, firms must efficiently use and allocate resources in a prudent manner. In this case, retained profits have led to the achievement of efficient allocation and use of resources. In a market economy, profits lead to the entry of other firms to the market. The rising profits signal to other producers the need to enter the market and share the supernormal profits. As Xianzhong (2010, p. 48) assert, the modern market economy is highly mobile economy. This assists in the optimization of human resource distribution. The firms that have accepted to enter a market having supernormal profits will not have any problem with the acquisition of human resources. The supernormal profit is an indication of possibly profitable entry into the market. Resources are then acquired by a firm in an efficient manner and use them for purposes of rivaling the existing firms and generate its own profit. As long as consumers still desire the commodities produced by these firms, firms will continue producing them. In short, demand governs production (Mukherjee 2002, p. 37). Resources are allocated to those goods and services that generate profit and firms align them efficiently. In the end, because of the need for profit to survive and have a viable business in a market economy, individuals will always allocate and use their resources efficiently. References Heath, J 2014, Morality, competition, and the firm: The market failures approach to business ethics, Oxford University Press, Oxford. Lipsey, R. G & Chrystal, K. A 2015, Economics, 13th edn, Oxford University Press, Oxford. Matutinovic, I 2010, ‘Economic Complexity and the Role of Markets’, Journal of Economic Issues, vol. 44, no. 01, pp. 31-52. Mukherjee, S 2002, Modern Economic Theory, 4th edn, New Age International, New Delhi. Myers, D 2012, Construction economics: A new approach, 3rd edn, Routledge, London. Xianzhong, Y 2005, ‘On Population Mobility in Market Economy’, Chinese Journal of Population Resources and Environment, vol. 03, no. 03, pp. 48-52. Read More