1. (c) Using a production possibility curve diagram,
analyse the effect of an increase in unemployment on a country’s output.
2. (d) Discuss whether the advantages of the market
system are greater than its disadvantages. [8] AS essay:
1. (a) An economy contains just two sectors, an
agricultural sector and an industrial sector. With the help of a diagram, explain how a production possibility curve (PPC) can be used to show the concept of opportunity cost and consider whether opportunity cost is likely to remain constant if resources are reallocated from the agricultural sector to the industrial sector. [8]
2. (b) Discuss whether the price mechanism is an
effective way to solve the basic economic problem. [12] The price mechanism is a term used to describe the means by which the many millions of decisions taken each day by consumers and businesses interact to determine the allocation of scarce resources among competing uses. Invisible hand of the "price mechanism" operates in a competitive market through the pursuit of self-interest to allocate scarce resources in society's best interest. This remains the essence of the ideology of free- market system. In a free market economy with limited government involvement, price mechanism is the organizing force. It functions as a signal and an incentive for producers to act in the required way to maximise their gain, which, in turn, optimises the allocation of resources. Everyone in this system is motivated by pure self-interest. Consumers maximise welfare, firms maximise profits and the private individuals aim to maximise the rewards of resources they own. It is argued that in doing so individuals will be guided as if by an •invisible hand' to achieve maximum social welfareforthe nation as a whole. There is consumer sovereignty i.e. through price system, consumers indicate their wishes and community^ productive resources are allocated accordingly. In addition, firms keep production costs as low as possible to obtain highest profit margin. Thus, allocative and productive efficiency will occur. The government's role is to protect intellectual property rights through patents & copyrights. Hence, there are incentives for firms to be innovative and produce better quality products. Firms also compete with each other on price and always be looking to produce something new to get ahead of their competitors It is of no surprise, therefore, that consumers benefit from lower prices, better quality, and a much larger choice of goods and services.
However, the outcome of price mechanism is undesirable
when markets malfunction. Market failure occurs when the signaling and incentive function of the price mechanism fails to operate optimally leading to a loss of economic and social welfare. For example, public goods such as streetlights cannot be provided privately because of their two characteristics, non-rivalry and non- excludability. These goods have to be provided publicly or else they will never be produced through price mechanism. Another failure occurs in case of merit and demerit goods. Consumer preferences to consume these goods and services may be based on imperfect information on the costs and benefits. Thus, merit goods, like health and education, tend to be under consumed and demerit goods, like cigarettes and alcohol are over provided.
Also, while responding to price mechanism individual
producers base their production decisions on private rather than social costs. Therefore, the market may fail to take into account the external costs and benefits arising from production and consumption. Moreover, in some markets individual preferences may be distorted and shaped by the effects of persuasive advertising and marketing to create artificial wants and needs. On top of these, the system may be judged as 'un*fair because there may be considerable inequalities in both income and wealth arising from the operation of price mechanism. Since the wages for labour are determined by the forces of demand and supply, therefore, all those who can afford and obtain better education or are blessed with particular talent, that is high in demand, will be able to command higher incomes and hence, larger share from the nation's output. Others may not be so fortunate and thus receive far lower incomes and comparatively a lower share from the nation's output.
Like any other system, the capacity of price mechanism
to solve the problem of scarcity is limited. However, the system, by far, seems to be more effective in dealing with the problem yet its effectiveness depends on the degree of failure. Overall, with all its merits, price mechanism does not solve the problem of scarcity but is considered effective in dealing with the problem when operating efficiently.