Markets and Resource Allocation

Adam Smith believed that the 'invisible hand' of the market would allocate resources to everyone's advantage. There are three main types of actor in the market system: 1- onsumers !- "roducers #- $wners of %actors of "roduction. onsumers and producers act in the goods markets of the economy. "roducers and owners of factors of production &land' labour and capital( interact in the factor markets of the economy.

Actors in the act

The consumer: )n a pure free market system' the consumer is the one all powerful. *ith a wide variety of goods and services available' consumers are free to spend their money in the way they want. )t is assumed that the consumers will allocate their scarce resources in so as to ma+imise their welfare' satisfaction or utility. The firm: )n a pure free market' firms are servants of the consumers. They are motivated by making as high profit as they can. This is to say' ma+imising the difference between their costs and ,evenues. )f firms fail to produce what the consumers desire they will not be able to sell. onsumers will' instead' buy from firms which are producing their desired good or service. -ence' successful companies wil have higher revenues while unsuccessful ones will have .ero or no revenues. Similarly' if firms fail to minimise their costs' they will fail to make a profit. $ther' more efficient firms will steal the market by selling at a lower price. %irms have to make sufficient profits to retain resources and prevent the owners of factors of production from allocating their resources in profitable ways. Similarly' firms cannot make more than average profits. )f they did' other firms will also enter the market' enter the market attracted by high profits' ultimately driving down prices and profits and increasing output.