Civil Engineering Reference
In-Depth Information
make choices. The flow chart in
Figure 2.2
suggests how the price mechanism
works. For example, when supply exceeds demand a price change occurs which
brings the producers and consumers into harmony. This is precisely what happens
during the January sales: the price of stock that has not been previously sold is
reduced, to the point where demand is sufficient to clear the market. Conversely,
when demand exceeds supply, the price of the good in question will rise until the
market is in balance. This may be seen at a property auction where, to begin with,
several buyers compete for a specific property: together they bid the price up, until
finally there is only one interested party prepared to pay the final purchase price to
the
vendor
.
Prices can thus be seen to generate signals in all markets (including factor
markets): they provide information, they affect incentives and they enable buyers
and sellers to express opinions. And, providing that prices are allowed to change
freely, markets will always tend towards equilibrium, where there is neither excess
demand nor excess supply. To put it another way, in a truly free market the price
determination of goods and services has nothing to do with the government. By
allowing the forces of supply and demand to operate freely, the economy finds its
own natural balance.
It may be self-evident by now that other terms used to describe the free market
economy are 'market' or 'capitalist' economy.
Summary: What? How? For Whom?
What
In a free market economy, consumers ultimately determine what will be
produced by their pattern of spending (their voting in the marketplace).
As far as producers are concerned, their decisions about what goods to
produce are determined by the search for profits.
How
Since resources can substitute for one another in the production
process, the free market system must decide how to produce a
commodity once society votes for it. Producers will be guided (by the
discipline of the marketplace) to combine resources in the cheapest
possible way to achieve a particular standard or quality. Those firms
that combine resources in the most efficient manner will earn the
highest profits and force losses on their competitors. Competitors will
be driven out of business or forced to combine resources in the same
way as the profit-makers.
For whom
The 'for whom' question is concerned with the distribution of goods
after production. How is the pie divided? In a free market economy,
production and distribution are closely linked, because incomes are
generated as goods are produced. People get paid according to their
productivity; that is, a person's income reflects the value that the
market system places on that person's resources. Since income largely
determines one's share of the output 'pie', what people get out of the
free market economy is based on what they put into it.
