Question

Discuss How do markets provide for an efficient allocation of scarce resources? Provide examples

Answer 1

It shall be noted that the market system is a system where buyers and sellers interact without the intervention of government regulations. Inherent in this system is the concept that sellers want to gain maximum price for the goods, services, and resources offered and buyers want to receive value for the lowest price. The balance of this relationship leads ultimately to the market equilibrium price.

However, important to note in this system is that all factors external to the “Market” have no effect on this relationship that is government regulations or policies. Resources are therefore strictly allocated to the production of those goods which give the sellers maximum return and correspondingly give the consumers the maximum satisfaction of their wants at a market price.

Price acts as an indicator to both the consumers and the sellers within the market (Price Signals as Guides for Resource Allocation)

Given accurate price information, the sellers will use high priced scarce raw materials, (e.g copper market) or resources to produce goods of high value. Likewise, only those consumers who see the benefit in consuming those higher valued goods will demand them, therefore, achieving a balance within the system. Similarly, where the price of a readily available resource is low it will be allocated by the resource users for use to produced goods in a lower-valued tier and consumer behavior will also react accordingly.

To summarize, the shifts in the price of privately owned resources within free-market results from the shifts in the demand and supply of the resource i.e. capital, labor, raw material. This is believed to lead in turn to efficient resource allocation by the resource owners through:

1) (Expanding the supply) Reallocating resources to the production of high priced goods.

2) (Contracting supply) Reallocating resources away from the production of low priced goods.

3) Reallocating resources to the production of goods in high demand by consumers in order to absorb excess demand.

4) Reallocating resources away from the production of goods in low demand in order to absorb excess supply.

Thus, this is how the markets provide for the efficient allocation of scarce resources, which is based on private consumption, production decisions, or a combination of both at the market equilibrium price.

Example - Diamond. It is a scarce resource in the manufacture of the diamond jewellery. The price of diamond is determined by the market forces of demand and supply.