The (Free) Market System (CIE IGCSE Economics)

• In order to solve the basic economic problem of scarcity, economic systems emerge or are created by different economic agents within the economy
  
  • These agents include consumers, producers, the government, & special interest groups (e.g. environmental pressure groups or trade unions)
  • Any economic system aims to allocate the scarce factors of production
     
• The three main economic systems are a (free) market system, mixed economy, & planned economy
  
  

What Determines The Economic System Of A Country  

How the three questions are answered determines the economic system of a country

   

• Economic decisions need to be made to answer three important questions

1. What to produce? As resources are limited in supply, decisions carry an opportunity cost. Which goods/services should be produced e.g. better rail services or more public hospitals?
   
   
2. How to produce it? Would it be better for the economy to have labour-intensive production so that more people are employed, or should goods/services be produced using machinery?
   
   
3. For whom are the goods and services to be produced? Should goods/services only be made available to those who can afford them, or should they be freely available to all?

  
How These Questions Are Answered Determines the Economic System

Type of System	What to Produce?	How to Produce?	For Whom?
Market System	Demand & supply (the price mechanism)	Most efficient, profitable way possible.	Those who can afford it
Mixed System	Demand, supply & the Government	Some efficiency but also a focus on welfare/well-being	Those who can afford it, plus some provision to those who cannot afford it
Planned System	The Government	Ensure everyone has a job	Everyone

• A market system works to allocate scarce resources efficiently, purely through the forces of demand & supply (the price mechanism)
  • There is no government intervention in a pure market system (no taxes or government spending)
  • In reality, there is no economy which is a pure market system
     
• In a market system, prices for goods/services are determined by the interaction of demand & supply 
  • A market is any place that brings buyers & sellers together
  • Markets can be physical (e.g. McDonald's) or virtual (e.g. eBay)
     
• The price mechanism is the interaction of demand and supply in a free market
  • This interaction determines prices which are the means by which scarce resources are allocated between competing wants/needs
    
    
• The price mechanism fulfils several functions in an economy
  • Prices allocate (ration) scarce resources. When resources become scarcer the price will rise further. Only those who can afford to pay for them will receive them. If there is a surplus then prices fall & more consumers can afford them
  • Prices provide information to producers & consumers where resources are required (in markets where prices increase) & where they are not (in markets where prices fall)
  • When prices for a good/service rise, it incentivises producers to reallocate resources from a less profitable market to this market in order to maximise their profits. Falling prices incentivise reallocation of resources to new markets 

• Equilibrium in a market occurs when demand = supply
  
  
• At this point the price is called the market clearing price
  • This is the price at which sellers are clearing their stock at an acceptable rate

A graph showing a market in equilibrium with a market clearing price at P and quantity at Q

• Any price above or below P creates disequilibrium in this market
  • Disequilibrium occurs whenever there is excess demand or supply in a market