<2.9 MARKET SYSTEM>

--DEFINITION--

--DO YOU REMEMBER THIS CLIP FROM UNIT 1.2?--

--REMINDER TASK--

Did the castaway get what he wanted?
Did he produce what he wanted in the most efficient way?
Did he get it for free? Any cost?

--WHAT IS A MARKET SYSTEM?--

"A MARKET ECONOMIC SYSTEM" is one where THE ALLOCATION OF SCARCE RESOURCES IS DETERMINED BY THE FREE MARKET FORCES OF SUPPLY AND DEMAND through the PRICE MECHANISM, and in which MOST RESOURCES ARE PRIVATELY OWNED, WITH LIMITED GOVERNMENT INTERVENTION.
A market system is like a big game where everyone tries to get what they want. It's a system where people decide what to make and sell, and how much to charge for it. The price of things is decided by how much people want them (demand) and how much is available (supply). Most things are owned by individuals or companies, and the government doesn't interfere too much.

--ADVANTAGES--

FIRMS, SEEKING PROFITS, PRODUCE WHAT CONSUMERS WANT?

As we have seen in unit 2.6 when consumer demand increases it creates a SHORTAGE and the price begins to be 'BID-UPWARDS', like at an AUCTION, which in turn sends a price SIGNAL to producers that they can charge a higher price for the good. With the INCENTIVE OF PROFIT, they will REALLOCATE resources TOWARDS producing more of this good and away from producing goods with lower returns. In addition, NEW FIRMS WILL ENTER the market attracted by the higher profits resulting in a movement up the supply curve. As such in this system the answer to the "WHAT TO PRODUCE?" economic question is determined by CONSUMERS ever changing desires.
Below is an example of how the power of free markets have resulted in changing phone designs to meet changing consumer tastes and demands. As the demand for the goods on the left falls signaled by falling prices, producers reallocate resources towards the goods on the right which have increasing demand and prices.

--TASK--

Think of a similar 'CHAIN OF DEVELOPMENT' that exemplifies this function of the market system.

ONLY THE MOST EFFICIENT PRODUCERS SURVIVE?

One of the major factors that contribute to the success of the market system is 'COMPETITION', which keeps PRICES AT THEIR LOWEST and QUALITY AT ITS HIGHEST (If the price is too high then you can buy cheaper, so prices stay low and firms compete on quality and service, which in turn ENCOURAGES INNOVATION so that firms can get ahead of its rivals). You would be a fool to think that a UK firm could produce garments cheaper than a Bangladeshi firm, as such a UK firm would not allocate its resources to this market, leaving it to the LOWEST COST producers in Bangladesh, who in turn must make sure the QUALITY is sufficiently HIGH to beat other low cost producers in Vietnam etc... This low cost is achieved through EFFICENCY and MINIMISING the wastage of SCARCE RESOURCES. As such in this system the answer to the "HOW TO PRODUCE?" economic question is determined by the PRODUCERS, seeking to minimise costs and maximise profits.
For example, there are so many bubble tea brands in Taiwan keeping the price low and the quality high.
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ALLOCATIVE & PRODUCTIVELY EFFICIENCY ACHIEVED?

As we have seen if prices are too high the surplus lowers prices, and if the price is too low the shortage raises prices and we end up at and equilibrium price and quantity which in economics is considered both Allocative and Productively efficient as
"..the market system has allocated the maximum number of resources possible to meet the desire of consumers using the most productively efficient (lowest average cost) producers."
This means at that any quantities to the left or right of equilibrium are considered INEFFICIENT outcomes.

--TASK--

Apply your understanding of efficiency to explain why Mr. Bounous would not enter the market as a producer of 'stinky tofu'.

--DISADVANTAGES--

--MARKET FAILURE CAN OCCUR--

MARKET FAILURE can occur when MARKET FORCES ALONE FAIL TO ENSURE THE ALLOCATIVE EFFICIENT LEVEL OF OUTPUT. This can occur WHEN...

...THE PRODUCER'S COSTS/BENEFITS ARE NOT FULLY INCLUDED:

"What if firms only take into account the private costs and benefits to themselves, and not the costs and benefits of their decisions to others (3rd parties), does this mean their supply curves are inefficient?"
THINK ABOUT IT!: Do you think a factory takes into account the costs of it's CO2 emissions to third parties that inhale their toxic fumes? Does the market system provide a method to compensate the third party? Surely finite resources that you can't charge people from exploiting will eventually be destroyed forever?

...THE CONSUMER'S COSTS/BENEFITS ARE NOT FULLY INCLUDED:

What if consumers only take into account their private costs and benefits to themselves, and not the costs and benefits of their decisions to others (3rd parties), furthermore, what if their perceived private benefits are not accurate and distorted by lack of information etc... doesn't this mean their their demand curves are inefficient?
THINK ABOUT IT!: Do you think a cigarette consumer's demand takes into account the costs of passive smoking treatment for third parties that inhale their smoke? Does the market system provide a method to compensate the third party?

...CUSTOMERS CAN'T BE CHARGED INDIVIDUALLY:

Firms will not make products unless they think they can charge for them so what if there are some products, which all people want, but firms won't provide because consumers are unwilling to pay for on an individual basis, surely there will be no allocative efficiency as the market for this product won't even exist?"
THINK ABOUT IT!: Do you think it would be possible to buy a National Earthquake/Tsunami warning system? Why not?

...THERE IS NO COMPETITION IN THE MARKET:

What if there are barriers to competition and new firms can't enter and one firm can set prices as high as they like (Have you heard of a monopoly?), how will the allocatively efficient quantity be achieved?
THINK ABOUT IT!: Do you think if Coca Cola raised the prices of all its beverages at once (They have over 200 brands), people would easily go and buy cheaper alternatives? Do you think it would be possible to enter and compete with Walmart?

...BUYERS/SELLERS LACK INFORMATION ABOUT TRUE VALUE/COST:

The assumption is that consumers have FULL INFORMATION about the benefits they will gain from consuming a good and use this to guide their willingness to pay. For example you have a good idea about the benefits of consuming a banana, and therefore can make an 'informed decision' about how much you are willing to pay, but what if you lack the knowledge or are persuaded by advertising and pay a price that isn't really informed, in this case your demand curve will not be optimal and the efficient level will not be achieved.
THINK ABOUT IT!: Do you think you are 100% sure about the benefit that owning a MacBook will give you? Do you think the seller of a second hand phone is telling you the entire truth? Do you think the insurance customer is revealing all their illnesses when they negotiate insurance? How has 'branding' impacted your decision?

...RESOURCES ARE IMMOBILE AND CAN'T EASILY BE REALLOCATED:

When we look at the market system and how the price mechanism works to reallocate resources we forget the ask whether these resources are actually mobile, for example can construction workers become programmers very easily? Of course not, can mountainous land be used for farming? etc..
THINK ABOUT IT!: Do you think if the wages of IB teachers increased Local teachers could move schools easily? Do you think Mr. B could become an AI Engineer? Do you think Madagascar could become an exporter of electric cars? What will AI do to the mobility of labour?

...INCOME INEQUALITY EXISTS:

In a market economic system the answer to the "FOR WHOM TO PRODUCE?" question is simply THE PAYING CUSTOMER. As we can see the only way to consume goods and services in a market system is to pay the market price, as such if you lack ownership of healthy and educated factors of production (such as your own labour) you will likely lack the income and go without.
Therefore INCOME INQUALITY is likely to occur as direct result of some of the aforementioned market failures as well as exacerbate them further. For example, the markets' failure to deal with monopoly power, corruption and the undersupply of quality merit goods such as education and healthcare, to name but a few, clearly has an impact on 'equality of opportunity' in society and the ability of individuals to generate income and create the competitive pressures needed for efficiency to occur.
THINK ABOUT IT!: Do you think the local butcher can be competitive against Walmart? Do you think the quality of pubic schools matches that of private schools? If the goal is to increase society's satisfaction, do you think an extra $1,000,000 to a billionaire gives more or less satisfaction than an extra $1,000 to a low income earner? Do you think the rich have a greater influence over political decisions than poor people? Do you think the external costs in terms of crime, domestic violence and vandalism that poverty creates outweighs the benefits of income equality?

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