Economic decisions need to be made to answer three important questions
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?
How to produce it? Would it be better for the economy to have labor-intensive production so that more people are employed, or should goods/services be produced using machinery?
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 a Market System Works
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 incentivizes producers to reallocate resources from a less profitable market
Equilibrium and Disequilibrium In Market
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
Any price above or below P creates disequilibrium in this market
Disequilibrium occurs whenever there is excess demand or supply in a market