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Market system and command economy try to cope with economic scarcity by answering the three basic economic problems. The fundamental economic problem is used as a guide to allocate resources among individuals and society in order to satisfy their unlimited wants based on the scarce or limited resources. In a market system resources and factors of production are owned by individuals. Therefore, the individuals decide on what to produce based on the market mechanism and level of profitability. The forces of demand and supply without any government intervention will determine how resources are allocated. The interaction between supply for each goods also determines how much to produce. How the goods or services are being produced is signifying on the methods of producing. In market system efficient used of scarce inputs plays an important role. Thus, the cost of production is minimized by using the least cost methods or techniques in order to maximize the profits. As market system are mostly motivated by profits, the goods and services produced are catered to those whom that can afford and willing to pay.
A command economy is controlled by the government as the government act as the central planner unit. The resources and factors of production are entirely owned by the government only. Therefore, the government decides on what and how much to produce based on its own forecast of what individuals need rather than what individuals desire or want as their main objective is to adopt economic equality or welfare among individuals. The command economy also determines how production will take place in order to complete its balanced resource allocation process. A low cost production or high cost production may be used in the command economy as long as it results to full employment rate which is a governmental objective. Good and services are produced to satisfy the needs of all individuals of a country, and not just for those who can afford to pay for goods and services.
Supply of a product may increase due to the change in cost of production. The cost of production includes the price of raw materials and wages of workers. For instant, price of cheese which is the raw material of making pizza has decreased. Therefore, the cost of making pizza is least costly and will increase supply of pizza. This factor would shift the entire supply curve of pizza rightward.
Changes in technology also result to an increase of supply of a product. Technological advancement reduces cost of production and increase productivity of a product. For example, when high-technology machinery like laser beams and computer is employed in a cereal making company, the supply of cereal will increase. Hence, shifting the entire supply curve of cereal rightward.
A government policy like subsidies is determinant which increases supply of a product. When government subsidies a production, supply of a product will increase as cost of production is being minimized while the profit is being maximized. For example, the granting of 70 cent per subsidy for each car seats produced will increase supply of car seats. Thus, supply curve of car seats will shift rightward.
When the price mechanism is not being held back, prices increase and decrease in order to balance between the quantity supplied and quantity demanded in a market. The price of a good would fall if at a particular price, supply of the good is more than what consumers demand for. Similarly, the price of a good would rise if there is shortage of supply to satisfy consumers demand. Price floors and ceilings prevent price mobility to change in order to reach equilibrium price. This phenomenon stifles the rationing function of prices.
When a price floor or minimum price is being set above the equilibrium price, suppliers would produce more than the market can support and result to inefficiency uses of the scarce resources. Price ceilings is set below the equilibrium price and leads to an under allocation of resources towards a certain good, where the shortage discloses that consumers value the good more than what the market currently offers. This occurrence distorts the resource allocation.
A decrease in demand will shift the entire demand curve leftward. Any change in the factors influencing the market demand curve, other than the price of the goods itself may lead to a leftward shift of the demand curve. For instant, a rise in price of petrol will decrease the demand for cars as they are considered as complimentary goods. Thus, the quantity demanded for petrol will decrease and represented as a movement upward along the same demand curve. Demand for cars will fall from 3500 units to 2500 units, depicted as a leftward shift from D0 to D1.
A decrease in quantity demanded will implicate to a movement upward along the same demand curve. The determinant affecting the movement along the demand curve is only caused by the price of the goods itself and ceteris paribus. For example, an increase in price of butter from RM7 to RM10 will result to a decline in quantity demanded for butter from 700 units to 400 units. This phenomenon is depicted as movement upward along the same curve from point C to B.
Income elasticity of demand is mathematically expressed as the ratio of the percentage change in the quantity demanded of a good or service based on the percentage change of the household income. On the whole, income elasticity of demand indicates the degree of responsiveness of demand in corresponding to changes in the income of the consumers. Degree of income elasticity of demand is classified into three groups, which is positive, negative and zero.
Positive income elasticity of demand is greater than 0. It can be further categorized into three types which is unit income elasticity of demand, elastic income elasticity of demand and inelastic income elasticity of demand. Unit income elasticity of demand is when percentage change in quantity demanded is proportional to percentage change in income where (YED=1). Inelastic income elasticity of demand is when percentage change in quantity demanded is smaller than percentage change in income where (0
Negative income elasticity of demand is less than zero. Percentage change of quantity demanded falls as percentage change of income rises. Examples of goods having this demand elasticity are inferior goods like instant noodles and used hand phones.
Zero income elasticity of demand is exactly zero. When percentage change of income increases, percentage change of quantity demanded remains the same. The goods are necessity goods like rice and cooking oil.
The concept of consumer surplus can be expressed as the difference between the prices consumers are willing and able to pay for a good or service and the prices consumers actually pay. It is the area between equilibrium price and demand curve. The consumer surplus is actually the benefit consumers gain by paying lesser amount for a product or service than what they are willing to pay.
The concept of producer surplus can be expressed as the difference between the price producers are willing and able to receive based on supply for a good and service, and the price they actually receive. It is the area between equilibrium price and supply curve. The producer surplus is basically benefit that producers gain by selling goods or services at higher price than what they are willing to sell.
The production possibility frontier exemplifies the three economic concepts which is scarcity, choice and opportunity cost. A PPF shows the different combinations of two goods or services that can be produced with the given resources or factor of productions in the most efficient way. Since the economy is facing scarcity of the resources, choices need to be made between the productions of two goods. Production of good chosen must be able to maximize the satisfaction of the society and as well as the profit for producers. Most choices involve opportunity costs. The production of good forgone is the next best choice which cannot be produced. For example, producing more butter requires that resources to be channeled from production of guns to production of butter. In order to produce more butter which can be seen on PPF : C, more production of guns has to be forgone
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Wikipedia 2010, Economic surplus, online, retrieved 17 May 2010, from http://en.wikipedia.org/wiki/Economic_surplus
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McConnell, L.Brue, Flynn, 2009. Microeconomics: Principles, Problems, and Polocies, 18th ed. The McGraw-Hill Companies.
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