Market and Mixed Economies

The functions of price in a market economy

• Price is a rationing device. Goods that are in limited supply will go to those who are prepared to pay the most.
• Price is a signalling device. An increase in demand raises price and causes supply to expand (i.e. a movement along the supply curve) and vice versa. An increase in supply causes demand to expand (i.e. a movement along the demand curve) and vice versa.

The advantages of free market economies

• Efficiency: firms in a free market economy have to produce at the lowest possible average cost because otherwise they will find they cannot compete with other firms.
• Consumer sovereignty: consumers decide what they want to spend their money on and supply adjusts accordingly.
• Automatically adjusting: as market conditions change, quantities demanded and supplied automatically adjust.

Disadvantages of free market economies

• No provision of public goods. Public goods are goods that it is impossible to stop someone consuming (non-excludability) and also their consumption by one person does not reduce the amount available to others (non-rivalry). An example of a public good is national defence. Everybody in the UK is being protected by the armed forces and it is impossible to…