The free market system of resource allocation

‘People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices’

Adam Smith, Wealth of Nations, Book 10, Ch. VIII, (1776)

Often, as Adam Smith noted above, the marketplace is influenced by the growth of monopolies, mergers, and cartel-type activities which often use their market power to the detriment of consumers.

a) Examine the arguments in favour of a free market system of resource allocation (50 marks).

b) Explain how ‘market failure’ can occur and suggest how the government in a country of your choice has sought to ‘correct’ those market failures (50 marks).

Free market is a market in which there is the absence of economic interest and the various rules which are made by the government excluding stuffs like taxes, private contracts and the various rights of the land and home. It is some how the opposite of the controlled market where the government looks after the good and services and the mobility of labour , the price and the distribution rather than looking after the private ownership. Free market generally focuses on the fact that the production is solely private and not under government. Here free market is economy where the government doesn’t limit (by controlling the firms from internal and external market pressure) or promote (by contributing the subsidies) the administration and legislation of economic activity. (Annual Report, 2009) The free trade theory supports the idea of free market where the property is exchanged with price set by the sellers and buyers without harming each others property right. in this method the buyers are sellers are happy it the transaction .they simply get into trade with each other with the set price where there is no involvement of any third party such as government via transfer payment and without the use of physical power. The price is the reason for supply and demand in the market. Market is a place where the price of the products or services determines the allocation of resources to consumer satisfaction.

The arguments in the favour of free market system are:

Adapt changes:

As the demand for people needs changes day by day. Those commodities which are on high demand for particular product increases then they can start to produces those commodities which meets the needs of people today to rather than taking too long through government procedure. Since the demand changes they should able to produce those commodities which can satisfy the peoples current need.

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Leads to innovation:

The free market often leads to innovation. There is variety of new produces introduced in the market day by day to meet the requirement. The free market leads to innovation of new production to satisfy the needs of consumers which is changeable time to time. (Smith,2008) The often tend to produce unique items whose demand increases as they are newly introduced in the market. The market also encourages the new products and better innovative machines and methods for new commodity.

Competitive environment:

There is a huge competition in the market who create variety of products in the market .Market is a place where various commodities are produced to satisfy the need of people. People in the market produce new items day by day. They deal in a very competitive environment between the producers as everyone tends to produce new products. One should always look to produce items which can satisfy the customer’s current need.

Creates employment:

The free make creates employment in the market. They provide various chance of employment as they are paid more moderately on the quality of work you tend to do. And they tend to have better pay rates for the people.

Market is the cause of demand and supply not a monopoly:

Market is affected by the demand of a particular products and the supply of theses commodities rather than a monopoly. Its is based on the demand and supply not a owner of a company and there exist no monopoly. The seller is the one who decides the price, and the quantity to be supplies in the result of demand.

Cheaper rates:

The commodities in the market are generally cheaper. The customer can have access to all different kinds of commodities at cheaper price rather than buying it else where at a high price. (Webforum.2006) They tend to be cheaper as there is no tax, subsidies on the product and the price should also be agreed by the seller and the buyer.

Right to choice:

The customers have the right to choose at a free market. They can purchase the commodities which meet their demand and can also make a choice from variety of products. The have the full right to make purchase on the good they chose with the mutual understanding of the seller for price.

Market limits carefulness and authority:

In a Free market in a competitive market the player has no right to determine the prices and no player have power over anything in the market. The systems keep on changing and one has control over it. (Collins,2011) People are more concerned about the growing rise in the firm.

Market Failure

Market failure is market situation where the distribution of commodities in a free market is not well organized. Market failure can take place when the individuals take a selfish step to benefit them which however can be improved. Market failures are generally related with the non competitive market, externalities and public supplies. The market failure can also be taken as a good cause for government involvement in a particular market. (Annual report, 2007)The various types of taxes, subsidies, price control and policies including the method to correct the market failure can cause unproductive allocation of resources.

The various reasons for market failure can be summarized as:

Short term and long term environmental concerns:

The various deed of the agent can also lead to few externalities which are instinctive to production methods or few environments vital to the market. For example a steel producer captures is labour, capital and inputs and it is liable to pay to these at their respective market and those cost will be remarked in the steel price in the market. If they firm tends to harm the environment during steel production and if the firms are not made to pay for the use of resources ten the society is bound to pay for it.

Lack of public goods:

Lack of goods is when the government doesn’t provide the goods which are not found adequately free market. Preferably the government would make available all the good s that is not adequately found in a free market. Market failure takes place because the market fails with no public goods, however people won’t tend to buy theses as they are not profitable. Government are good source for preventing market failure (Economist.com,2010)

Abuse of monopoly power:

Monopolies have the full right to determine the price a commodity. High demanded commodity can be elastic as it will be ready to pay many price for it. Due to the inelastic good the price tend to rise causing a market failure as the supply isn’t inflated by the competition.

Externalities:

Externalities are not the cost of benefit of consumption made by the third party however produces nor can consumers cause them. Positive externalities are goods that cause benefit to the third party who don’t pay to receive theses benefits. They are low priced and under produced. Negative externalities are goods that enforce cost to third parties who are not involved. These are over produced goods that have low prices.

The steps taken by to stop market failure are:

Direct provision of merits and public goods:

Merits and public goods often lead to market failure as people generally are not willing to pay for it. (Westerfield, 2010) difficult o exist in this condition if UK is directly providing the commodity to customers there can be no market failure and also improves the infrastructure.

Legislation:

It is a set rule by the government of a country. It also deals with the market failure and to reduce the negative externalities and increases the directive of the commodities accountable to it with high price and low quantity.

Taxation:

This occurs when UK government increase the commodity price by imposing tax on the consumption of the good. High tax rate can decrease the consumption as less people will be willing to buy it at high rates. This creates competition in business and even substitute can occur due to price rise.

Subsidies:

With a good that has positive externalities the government tend to produce a subsidies to prevent market failure. This solely means the government will seek help from, the party that produces those externalities to increase production. When subsidies are specified then producers tend to produce more due to more capital with the marginal private benefit closer to marginal social benefit, with reduction in the positive externalities and stopping market failure.

International cooperation among governments:

The government and the organization bind to solve the externalities. the focal point is to create methods to equalize the marginal cost and marginal private cost . This however can’t be a beneficial as other method. UK should have monopoly with other countries on particular items so that they can benefit as well.

Advertising to encourage or discourage consumption:

Advertisement can be used to encourage or discourage consumption or production of those goods which can be positive negative externalities. Whenever there is deficit in the market the government persuade consumption or production, if a surplus is measure then the government dampen the consumption or production. (Holland, 1987) Talking about climate change in UK it is a result of pollution. To alert the people they do various advertisements or add to inform people about it. Commodities having positive externalities are created properly so governments what to increase the consumption of it where those over produced goods are discouraged

PART B

The problems in the global banking system have affected most major economies of the world. In response, governments have introduced monetary and fiscal policies to try to improve the situation. With reference to a country of your choice:-

a) Examine how the government of that country has adjusted its monetary and fiscal policy in response to the world downturn. Explain the reasoning behind these adjustments. (50 marks)

b) Indicate the problems which are created for the government’s finances as a result of it seeking to avoid an even deeper recession. (50 marks)

Recession can be defined as a situation where decline in economic activity takes place however it is shorter than depression. Recession effects the employment, inflation, incomes, spending capacity of people, profits from business and also leads to bankruptcies of few organizations. The recession has also majorly affected the economic sector such as house market, retail industry and also leads to bankruptcy for few banks. (Fargo,2002)

The Government of UK has taken various steps to stop the recession and they are:

Encourage imports of high priced commodities: The UK import and export has been ranked as the 6th in terms of exports and ranks 4th on the imports. The high priced commodities like the food products are always high in price and have been imported from various countries like middle east, Asia , US and Europe by imposing good amount of tax on them so that in brings stability on the price.

Fig: foreign trade from 1992-2002 Geroski & Gregg 1997)

Discourage borrowings: During the recession the borrowings for the public has been decreased as people who have trillions of pound on the bank began to panic and actually asking their funds back and they were not able to pay them back as the bank had lend a large amount of public and when the financial crisis started the people could not return it to back the big banks faced crisis like northern rock and lead to takeover. So due to recession the bank stooped giving credits to people in the fear that they couldn’t return it to the bank. ( times100.co.uk,2010)

FIG: ( times100.co.uk,2010)

The above figures shows that the UK seems to be the biggest debt borrower by the end of 2010 among the average G20 countries. The saving ratio has increased after the hit of recession from 4.8% in the year 2009 which

Encourage saving: The government has been aware about saving. Since recession people are more concerned about saving rather than spending. Even bank are warning people to save up for future from being bankrupt. The person has saved with a increase of 4.8% in the year 2009 which is highest after 2006. People have been more aware for the future and have started having in and even the bank provides various option and facilities on saving. The household has been more aware about spending after the crisis period.

FIG : Telegraph.co.uk

The figure reveals how the debt has decrease in the year 2009. The figure estimates that the people are now borrowing 6 billion pound from 14 billion pound by the 2009. (Telegraph.co.uk,2011)

Encourage foreign direct investments: Recession has hit the economic sector. The government should encourage FDIs and adopt new ways of international trade and investment abroad. The Investment overseas raises the demand of currency and exchange rate. The high currency rates are beneficial for domestic inflation and the foreign product needs less currency and its fewer prices when paid in the country itself.iyt also encourages employments and helps create better economic situation.

Encourage Export: The government has increased export of commodities .since the recession has hit the government is always looking for an extra fund. So they have adopted export which can be a new means of business expansion and entry of foreign currency with high value. The government is launched a new scheme to encourage export. Recently it has had a good partnership with turkey for an export of commodities. It creates innovation and maintains political stability and has low prices and benefits the industry with better competitive sources.

Inflation rises: The consumer price index UK said that inflation rate increased by 3.3% in November 2010 from 3.2% in October. It was due to the increase in the price of food, clothing furniture etc. The price of food, a drink were 1.6% rose on october-november but was up by only 0.6% on 2009.the vat rate was also increased from 17.5% to 20% by the start of 2011. The mortgage interest payments had increase from 4% to 4.5%.the furniture, household items and other also had an increase in 1.6%. The rise in the prices of all the basic needs has created a hazard for the people of low income. (Ralph,2008)

Fig: . (Ralph,2008)

The figure indicates the annual inflation and the government target which was 4.0% in January and rose to 3.7% by the end of December. The government is increasing prices to be safe for recession.

The problems face by the government to avoid recession:

Pay taxes promptly: The government should encourage all the working people to pay taxes prompt. Tax is a good source of income for the government as it can pull money for the government. The people should truly pay taxes as the fund paid by them to the government can be useful at the time of crisis .When the bank was at crisis the government spend 50 billion on buying shares for RBS, LLOYDS, HBOS. The government further made and expenses of 250 billion on credit scheme to create special liquidity scheme and as revealed by the government spokesman 50o billion were spend to save it . (McDermott, 2009) As he said every tax payer bears 15,770 pound to the government. The government has also increase the vat rat and tax rated to overcome the funds spend by the government.

National debt: The UK public sector had the debt of 867.2 billion which comes around 57.6%of the national GDP was said by the office of statistics. All the debt including the RBS, Lloyds, HBOS was £2,244.2 billion.

Fig (gurdian.co.uk,2010)

Here the National debt has fall down to 29% a 2002 and in 2002 it was increased by 30%amd 37% in 2002. This occurred as they govern meant spend on infrastructure .UK had the highest debt among many countries in the world. However the total national debt was in the first six month of 2010 21.6 billion with annual cost of 43billion (Guardian.co.uk, 010)

Transfer payment: These are the payments made by the governments to those who are in need in the county which also include job seekers allowances , child benefits and other housing benefits to these with low income level .these also includes pension, income benefit. They provide theses to the people with low income to maintain a better standard of living and fulfill the basic requirement ,Due to the recession may people were unemployed or had low income due to which the government was liable to pay these bodies even when they had low fund. The government invested a huge on these sectors.

U.K housing market: This is the second time fall in the house prices. According to National wide the famous mortgage providers in the UK said that there was fall of 0.9% in August 2010 with a decline of 0.5% in July. The current house price is set to be £166,000.00.The annual inflation in the housing market fell from 6.6% in July to 3.9% in August. It is said that the UK house prices has fallen double from February 2009. However the supply and demand imbalance increases the mortgage debt. The housing market has affected the UK economy and the government fund government had to pay to few banks to save them from liquidity as those people who had mortgage load to pay did not pay the bank and led the bank to depression.(Gurdian.co.uk,2010)

Fig : (Fargo,2002)

Northern Rock: Northern Rock can also be one of the major reasons that governments fund faced crisis. When in 2009 northern rock hit crisis than on market asked to Bank of England for emergence fund as they had no fund and there fun heavily relied on the market than on savers deposit to fund mortgage then The day after they depositors took out a fund 1.6 billion which was a major hit on the bank and they slowly took out money until the government had guaranteed them which also led the government to put some fund there.