SECTION 2: THE ALLOCATION OF RESOURCES

CHAPTER 6: the role of markets in allocating resources

Microeconomics: the study of the behavior and decisions of households and firms and
the performance of individual markets.
Macroeconomics: the study of the whole economy
Market: an arrangement which brings buyers into contact with sellers.
Economy: a system which provides a solution to the basic economic problem.
3 BASIC QUESTIONS: WHAT TO PRODUCE? HOW TO PRODUCE? FOR WHOM TO PRODUCE?
3 TYPES OF ECONOMIES: MARKET ECONOMY, MIXED ECONOMY, COMMAND/PLANNED ECONOMY.

MARKET MIXED PLANNED

Resources are jointly

allocated by the market
No government forces of supply and
HOW IT intervention, resources are demand and by the
Resources are allocated by
allocated by the market government. 2 main
WORKS the government (directives)
forces of supply and motives for government
demand intervention: (i) correcting
market failures and (ii)
reducing inequalities

Benefits from the main

Efficiency, product
PROS diversity, low price, high
quality, innovation
Low income/wealth
advantages of a market
inequality, no market
economy, and has the
failure, low unemployment,
potential to overcome its
high job security
main limitations

Inefficient production, low

Market failures (when the
market does not allocate
CONS resources in the best
possible way),
income/wealth inequality
Government intervention is product quality, low
costly (operational costs) incentives to innovate, high
and it can be misguided prices, narrow range of
(imperfect information, products, government
political interests, etc.) intervention is costly and it
can be misguided.
Private sectors: firms owned by shareholders and individuals.
Mixed economic system: an economy in which both the private sectors and public sectors play an
important role.
Planned economic system: an economic system where the government makes the crucial decisions,
land capital are resources are allocated by directives.
Market economic system: an economic system where consumers determine what is
produced ,resources are allocated by the price mechanism and land capital are privately owned.
Explain how resources are allocated in a mixed economic system.
Resources in the public sector are allocated by government decisions/directives. products are
produced by state-owned enterprises. resources are allocated to overcome market failure.
Resources in the private sector are allocated by the price mechanism/market forces / demand and
supply / firms / consumer sovereignty . profit provides an incentive for firms to produce what
consumers demand.
Explain how resources are allocated in a market system.
market forces (supply and demand) influence the allocation of resources through the price mechanism
resources are privately owned in a market system with little/no government influence
the profit incentive encourages firms to produce what consumers demand .a rise in demand for a good
or service will increase price encouraging more resources to be allocated to producing it
What is the difference between the private sector and the public sector?
The private sector is the part of the economy where market forces / price mechanism / producers and
consumers' decisions allocate resources . firms are owned by private individuals
The public sector is the part of the economy where the government makes the decisions / government
controlled l government-owned firms .
Define a mixed economy.
An economy with a private sector and a public sector .
An economy where some resources are allocated by the government and some by market forces/the
price mechanism(2).
Define microeconomics. Study /analysis of or focus on individual markets / economic agents e.g. individuals,
households, and firms .
 THE PRICE MECHANISM:
Price mechanism: The way in which the market forces of supply and demand interact and determine a
price that will allocate scarce resources between competing uses.

3 MAIN FUNCTIONS: SIGNALLING, RATIONING, INCENTIVE

Signalling function of the price mechanism: Prices convey information to both buyers and sellers.
INFORMATION IS WHAT ALLOWS BUYERS & SELLERS TO MAKE THE BEST POSSIBLE ECONOMIC
DECISIONS.
HIGHER PRICE ➔ THE PRODUCT IS MORE VALUABLE FOR FIRMS / COSTLY FOR CONSUMERS
LOWER PRICE ➔ THE PRODUCT IS LESS VALUABLE FOR FIRMS / COSTLY FOR CONSUMERS
Rationing function of the price mechanism: Prices restrict consumption to those buyers with a high
enough willingness to pay. (LAW OF DEMAND - MOVEMENT ALONG THE DEMAND CURVE)
HIGHER PRICE ➔ LOWER QUANTITY DEMANDED
LOWER PRICE ➔ HIGHER QUANTITY DEMANDED
Incentive function of the price mechanism: Prices encourage firms to allocate scarce resources to the
production of goods and services. (LAW OF SUPPLY - MOVEMENT ALONG THE SUPPLY CURVE)
HIGHER PRICE ➔ HIGHER QUANTITY SUPPLIED (MORE INCENTIVE)
LOWER PRICE ➔ LOWER QUANTITY SUPPLIED (LESS INCENTIVE)

“Invisible hand”: A metaphor for how the decisions of self-interested economic agents interacting within
a free market economy generate unintended benefits for the entire society. ADAM SMITH (1776)
WHAT IS GOOD FOR THEMSELVES IS ALSO GOOD FOR THE REST OF SOCIETY
EXAMPLE: LOWER PRICE, BETTER QUALITY, MORE DIVERSITY, NOT BECAUSE FIRMS CARE ABOUT
CONSUMERS, EVEN IF THESE ACTIONS ARE CLEARLY BENEFICIAL TO CONSUMERS, BUT BECAUSE FIRMS
WISH TO GAIN MARKET SHARES, AND EVENTUALLY MAKE MORE PROFIT.
CONSEQUENCE: THE GOVERNMENT SHOULD NOT INTERFERE WITH THE ECONOMIC DECISIONS OF
FIRMS AND INDIVIDUALS (LAISSEZ-FAIRE)

Analyse how the price mechanism influences the allocation of resources in a market
economy.
An increase in demand will increase price this will provide a financial incentive / profit motive to
supply more of the product . resources will move away from less popular products. An increase in
supply will reduce price this will lead to a rise in demand resulting in more resources being devoted to
the product. Making use of demand and supply /consumers make the decisions/consumer sovereignty
will encourage firms to use the most cost efficient methods of production e.g. will use labour intensive
method of production if ready supply of labour
reward up to 3 marks for a correctly labelled demand & supply diagram, showing 3 elements of the
above e.g. shift (1) change in price (1) and new equilibrium quantity .