We’ve gone over the basic outline of what defines a market system. Let’s take a closer look at how it functions. Any given economic system must be able to answer the following five questions:
-What goods and services will be produced?
-How will the goods and services be produced?
-Who will get the goods and services?
-How will the system accommodate change?
-How will the system promote progress?
Let’s see how the frame work of the market system answers these questions.
What Goods and Services Will Be Produced?
There are two parts to this answer. First, there needs to be a demand for this product; in other words, consumers need to want this good or service. Second, businesses need to be able to provide this good or service at a profit. Remember that self interest is the main motivating factor in the market economy; we do what we believe will benefit us the most. So entrepreneurs and businesses are going to produce the things that satisfy their own self interest, i.e. produce what makes a profit for them. As long as an industry continues to provide a profit for the resources that are put in, then that industry will expand. New firms will enter that market and current firms will grow. When that industry ceases to provide a profit, then it will begin to contract. Fewer and fewer resources will be devoted to it. Some firms will shrink while others will exit that market altogether. That will continue to happen until that market picks back up and businesses realize profits again or until that market collapses and disappears all together.
How Will the Goods and Services Be Produced?
Firms are going to produce their products in the manner that costs them as little as possible. They have the self interest motivator to be efficient in production because they want to minimize cost in order to maximize benefit. If that isn’t enough, remember that the market system is a competitive one; there are rival firms who are constantly innovating, trying to take away your sales. So firms will use some combination of land, labor, capital, and entrepreneurial ability that costs the least amount of money. As technology and resource prices change over time, the least costly combination will change with it. As that happens, firms will adjust their production process. For example, if the price of labor falls, then a firm might decrease the amount of machinery (capital) it employs and hire more workers instead. It isn’t necessarily about using the fewest resources as it is using the cheapest combination of resources.
Who Will Get the Output?
Now that the goods have been made, who’s going to buy them? In short, those who are willing and able to. It may sound a bit harsh, but just because you want something doesn’t mean that you can have it. In order to acquire something in the market system, you need to have the means to be able to pay for it. Similarly, just because you can afford something doesn’t mean that you’re going to buy it; you need to want it as well. The higher your income, the more of society’s output you’ll be able to afford.
How Will the System Accommodate Change?
There are a lot of moving parts in an economy; trends change, new discoveries are made, and the amount of resources available fluctuate. A good economic system needs to be able to smoothly adjust to all these changing components without generating too much waste. As you may have guessed, the market system is very efficient at this.
The main regulating force in the market system is price and it is through prices that all these changes will take place. As consumer taste changes, the amount of money a firm makes will change, which will cause them to alter the price and how much that product they produce. As technology improves, different production processes become more efficient, leading to different resource prices, altering the least costly combination of resources for production. Running out of one resource and finding more of another will once again affect resource prices, changing the least costly combination of resources for production. Like I said earlier, firms will try to produce at the lowest cost possible in order to make the most profit. If there is a change to the system that leads to a lower production cost, they will move to it. Resources will be reallocated form higher cost production to lower cost production. Similarly, if there is a change that will lead to a higher profit, they will move to it. Resources will be reallocated from lower profit production to higher profit production. Firms have an incentive to keep up with change and stay ahead of their rivals because of the competition factor.
How Will the System Promote Progress?
Remember the original problem that economics is trying to tackle: there aren’t enough resources in the world to meet all of our wants so we have to find the best way possible to utilize them. Eventually, we’re going to run out of resources so we want to be as efficient as possible with what’s available to us. A good economic system will always be innovating, finding more efficient ways to work, and driving waste and costs down while increasing production. That will allow the economy to have a greater output and therefore have a higher standard of living.
The market system works in two ways to accomplish this goal. It promotes technological advance through competition. Better technology means increased production and lower costs Because of competition, firms have a huge incentive to discover this technology before their competitors. The technological advances that are made will also spread quickly throughout the system because competitors either have to adopt the new means of production or find one of their own that matches the increased efficiency. If they don’t, they’ll be left behind in profits and will eventually be driven out of business. The market system also promotes capital accumulation as technological advances often require more capital to take advantage of them. As entrepreneurs make a profit, they’re encouraged to take some of that money and reinvest it back into their own businesses in the form of capital goods (goods that help you produce other goods). This increases the firm’s productive capability (and therefore the economy’s productive capability) over the long haul. Making an investment in capital goods is making an investment in the future.
What goods and services will be produced?
-The ones that consumers want that will be able to provide a continuing profit to businesses.
How will the goods and services be produced?
-In the manner that costs the least amount of money.
Who will get the goods and services?
-Those who are willing and able to purchase them.
How will the system accommodate change?
-Through the changing of prices.
How will the system promote progress?
-Through competition, firms have an incentive to find technological advances and accumulate capital.
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki. Flynn. Macroeconomics: Principles, Problems, and Policies. Boston: McGraw-Hill Irwin, 2009. Print.
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