GCSE Allocative Mechanisms & Problems of Transition

1. Different Allocative
Mechanisms &
Problems of
Transition
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2. Economic Systems.
• All societies/countries face problem of scarcity of
resources and unlimited wants.
• Basic questions societies have to answer:
• What is to be produced i.e. resource allocation.
• How it will be produced– i.e. method/technique.
• Who will get what is produced i.e. distribution.
• An economic system determines the method a society
uses to answer the questions above i.e. the allocation
of resources to satisfy competing wants of society.
• It is a complex network of individuals, organisations
and institutions and their social and legal
interrelationships
• The three economic systems are market, planned and
mixed economies.
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3. The Market Economy/ Market System
• Characteristics/Features:
• No government intervention: there are three main actors – consumers,
producers, and owners of private property (land and capital).
• Motivation by self-interest: Consumers, producers and property owners are
motivated by self-interest i.e. their decisions are based on private gain; individuals
– maximise satisfaction, producers – maximise profit, factor owners – maximise
incomes, governments - maximise social welfare.
• Private ownership: Nearly all factors of production; land, capital are privately
owned. Factor owners have the right to buy or sell their factors through the
market mechanism. Government protects peoples’ rights with laws.
• Free enterprise: Price mechanism or forces of demand and supply (invisible hand)
allocate resources among producers and consumers. e.g. land. Private firms (and
consumers) determine what to produce, how to produce them and distribute
them.
• Competition: There is competition because economic units are free to allocate
their resources as they wish. Producers will compete for the spending ‘votes’ of
consumers. Workers will compete for the spending ‘votes’ of employers.
• Decentralised decision-making: There is no single body which allocates resources
within the economy. It results from the countless decisions by individual economic
agents (invisible hand). Government intervention is minimal. 3

4. Advantages of The Market System
• Quick response to consumer’s wants: The free market brings consumers and
producers together to trade. It responds quickly to consumer’s wants. If consumers
want a good, or, service, its price increases and it becomes profitable to produce it.
Consequently, resources are moved into its production. In a free market, the
consumer is king (sovereign).
• Freedom of choice: The market system produces a wide variety of goods and
services to meet consumers’ demand, or, wants. Consumers have freedom of
choice (of goods). For example, in the soft drinks market, we may have fanta, coca-
cola, sprite, pepsi, mirinda etc
• Competition and efficiency: The profit motive and competition promote
efficiency. Producers try to use new and better methods and machines to produce
goods and services so as to reduce their unit costs and increase profit. Firms which
produce what consumers want at the lowest possible prices get high profits.
• No need for officials: The system does not need officials and civil servants to
decide what should be produced and distributed. The market system coordinates
the activities of billions of consumers who are making purchasing decisions. The
market helps them to decide these issues.
• Incentive for hard work: High incomes provide an incentive for people to work
hard and for entrepreneurs to set up and expand firms. 4

5. Weaknesses /Disadvantages of the
Market System (Market Failure).
• Public goods such as police force, street
lighting, sea defence are not adequately
provided.
• Merit goods are under - produced and under-
consumed e.g. education, health care.
• Unemployment may occur if it is not
profitable to employ some people.
• The harmful effects of production on society
may be ignored.
• Unequal distribution of wealth may occur
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6. The Planned Economy
• Government allocates resources i.e. determines the
goods and services which should be produced, how
they should be produced and distributed.
• The state (public sector) owns the main factors of
production e.g. land and capital.
• Prices of goods and services are fixed; they are not free
to change according to changes in demand and supply.
• Every item is allocated through rationing from
education and health care to clothes and food e.g.
people are allocated a flat to dwell in, schools etc
• Black markets where goods and services are traded
illegally, are a feature of all planned economies e.g.
Cuba.
• Government can intervene in markets to correct
market failures.
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7. Strengths / Advantages of Planned Economies
• Production of public and merit goods. Factors of
production can be organized to produce public goods such
as roads, electricity etc and merit goods such as education
and health care. Government knows best what is good for
the people.
• Equitable distribution of wealth: The distribution of
wealth is more equal because goods and services can be
priced so that everyone can afford them. No individual can
become extremely rich by making abnormal profit.
• Checking environmental pollution: The government can
make sure that factories do not cause environmental
pollution and people work in a healthy and safe
environment. Government can deal with externalities.
• Redistribution of profit: The state owns the factors of
production and any ‘ profit’ made from production of
goods and services can be redistributed so that the people
who contribute to it can benefit from it. 7

8. Weaknesses / Disadvantages of Planned Economies
• Shortage of Goods: There is no price system; prices are fixed by
government Shortages of some goods and surpluses of others could
be a constant problem.
• Production of poor quality goods: Producers have no incentive to
ensure that high quality goods are produced. Hence, they produce
poor quality goods.
• Bureaucracy and inefficiency: Planned economies experience long
delays in providing goods and services. In addition, there is gross
inefficiency in most public- sector organizations.
• Lack of choice: This is a common problem facing command
economies. Government decides which goods should be produced
but government may be out of touch with the wants and needs of
the people.
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9. The Mixed Economy
• It consists of a private sector and a public sector i.e. a
mixture of market and planned economies. Private firms
produce some goods and services and government
provides public and merit goods.
Characteristics:
• The main actors: The four main actors within the economy
are consumers, producers, factor owners and government.
• Motivation: In the private sector of the economy,
consumers, producers and factor owners are motivated by
self-interest. the public sector is motivated by
considerations of the ‘good’ of community.
• Ownership: Resources e.g. land and capital are owned by
both the private sector and the public sector.
• Competition: In the private sector of the economy, there is
competition and freedom of choice. In the public sector,
resources are allocated through the planning mechanism
and there is no choice. 9

10. Advantages of Mixed Economies.
• Provision of public and merit goods: In a mixed economy, government
is able to provide public goods such as defence, law and order and
street lighting. Similarly it is able to provide merit goods such as
education and healthcare for people regardless of their ability to pay for
them. The whole economy will benefit from having a healthy and
educated population.
• Creation of Jobs For The Unemployed: Creation of jobs for the
unemployed. In a mixed economy, government may be able to create
jobs for the people by employing them in the police, army, civil service,
or, assist private firms to provide jobs. Also, the public sector
(government) can provide welfare benefits and payments to people out
of work or, on low incomes.
• Controlling the production of harmful goods: The government can
enact laws to make the production of harmful goods illegal and impose
high taxes on cigarettes and alcohol to reduce their consumption.
• Checking environmental pollution: Laws, high taxes and fines can be
used to protect the environment and peoples’ health. Firms may have
to pay large fines if their activities break these laws.
• Income Distribution: The government can plan to assist poor people by
giving them unemployment benefit. This will bridge the gap between
the rich and the poor. 10

11. Disadvantages of Mixed Economies.
• Effect of high taxes: In order to provide goods and services, or,
unemployment benefits governments may impose high taxes on
profits and incomes. High taxes on profits and incomes may
reduce enterprise and high taxes on wages can reduce people’s
incentives to work. Consumers will also less money after tax (or
disposal income) to spend on goods and services they want.
• Effect of regulations: Regulations impose significant costs on
firms. Hence, they may produce less goods and services, increase
their prices, or, reduce the wages of their workers.
• Inefficiency: Public sector firms are grossly inefficient. They
produce poor quality goods and because they lack the profit
motive.
• Politically motivated expenditures: In a mixed economy
government spends money on the provision of public and merit
goods. Very often, however, such expenditures are politically
motivated ie projects are undertaken in order to win political
votes.
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12. Transition Economies
• An Economy that is changing from central planning to free markets
e.g. Soviet Union.
• The problems of transition economies
• Rising unemployment: newly established private firms became
subject to greater competition which created job losses
• Rising inflation: Many transition economies also experienced price
inflation as a result of the removal of price controls imposed by
governments
• Lack of entrepreneurship and skills. Many transition economies
suffered from a lack of entrepreneurs and entrepreneurship, which
make it more difficult to reform their economies and promote
market capitalism
• Corruption. It is alleged that corruption was widespread during the
early years of transition in many former communist countries, and
this inhibited the effective introduction of market reforms. Many
products were poorly made and sold in unregulated and illegal
markets
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13. Transition economies (cont)
• Lack of infrastructure: The transition economies also
suffered from a lack of real capital, such as new
technology, which is required to produce efficiently.
This was partly because of the limited development of
financial markets, and because there was little inward
investment from foreign investors
• Lack of a sophisticated legal system: Under
communism, the state owned all the key productive
assets, and there was little incentive to develop a
sophisticated legal system that protected the rights of
consumers, and regulated the activities of producers.
• Inequality: Economic transition also led to rapidly
increasing inequality as some exploited their position
as entrepreneurs and traders in commodities, while
others suffered from unemployment and rising
inflation.
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