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Macroeconomics II –The market system

The basic economic problem

1.1 Allocation of scarce resources

Given that resources are limited (‘scarce’), it is not possible to make everything
everyone would want (‘unlimited wants’). All societies are thus faced with a
fundamental economic problem:

 What to produce?

 How many to make?

 Who makes them?

 Who gets them?

1.2 Possible solutions

 Command economy Decisions made by the Government

 Free/market economy Allocated by market forces via price mechanism

 Mixed economy Mixture!

1.3 The price mechanism – based on choice

Allocation of scarce resources
Price D S In a free market, the quantity and price of
goods supplied are determined by the
interaction between supply and demand
P’
A market price will be set by the “invisible
hand of the market” through the interaction.

Q’ Quantity It determines the allocation of scarce
resources between competing uses

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