Due to a minimum government intervention in a market economy, there is a freedom of enterprise. People are allowed to organise themselves into business units where they organise factors of production. The main advantage of the market economy is in its price mechanism. The price mechanism is the channel by which consumers’ signal to producers on the goods they want and the respective quantity they want. Through this system, thousands of consumers and producers make decisions daily, basing on their own interests.
This system allows consumer sovereignty where resources are allocated according to the wishes of consumers. In order for the profit motivated producers to maximise their net revenue, they must produce goods according to consumer taste (consumer orientated) – the design, the colour, the make, the accessories and even the price they are prepared to pay. Consumers, for instance, will spend to maximise their satisfaction or utility. They cast spending “vote” between different products and different firms.
If consumer tastes change so that they want more coffee from starbucks and fewer burgers from burger kings, then they will spend more on coffee from starbucks and less on burgers from burger kings. Starbucks will collect more money from the sale of coffee, which they will use to expand production. Burger kings will be forced to lay off staff, buy fewer raw materials and in the long term shut factories. Profit is the signal to firms to change levels of production. When consumers demand more coffee, firms will expand production only if it is profitable to do so.
Increasing profits would also attract new firms such as 94? C and au bon pain into the industry, therefore the burger kings might probably close the burgers factories in order to set up new coffee factories. The companies that receive the most profits will be able to purchase the factors of production needed to produce the goods demanded by consumers. As a result, the system allows the allocation of a society’s limited land, labour, and financial resources toward the kinds of production that most nearly satisfy the tastes and preferences of its people.
This system is very efficient because decision making is completely decentralised. Producers respond at the local market level immediately to changing consumer preference. As freedom of enterprise and the profit motive are allowed, producers will use scarce resources as efficiently as possible, so as to keep costs down. Intense competition causes unit costs and prices to fall to the benefit of consumers. Buying mobile phone in the past would cost a great deal of money, but today buy 1 get 1 free! (hutch). Intense competition also forces producers to innovate and invent new products.
For example, pizza hut has launched “pizza with suki topping” and Swensen has launched “green tea favoured ice cream”. In the long run, it is the consumer who benefits in the form of new, better and cheaper products. In a free market, the markets are highly competitive, no one has great power. Competition between firms keeps prices down and acts as an incentive to firms to become more efficient. The more firms there are competing, the more responsive they will be to consume wishes. The more efficiently firms can combine their factors of production, the more profit they will make.
The more efficiently workers work, the more secure will be their jobs and the higher their wages. The more carefully consumers decide what to buy, the greater the value of money they will receive. Thus people pursuing their own self-interest through buying and selling in competitive markets helps to minimise the central economic problem of scarcity, by encouraging the efficient use of the nation’s resources in line with consumer wishes. Therefore, this leads to efficiency where resources are used efficiently to satisfy consumers’ wants whilst the producers get the profits, which are their desires.
It would be misleading, though, to say that the free market is the winner without any provisions. Free markets with very limited governments would fail in other ways: poor health and education services, low state benefits and pensions and, perhaps the worst in a civilised society, an unfair distribution of income. According to the Karl Marx’s Theory, in a free market economy, there would be the exploitation of workers in the labour market. And as resource allocation in the free market economy depends on people income, each person has different access to goods and services.
This leads to inequity. Most of these problems do not exist if you are one of the richer members of society, but if you are poorer you have nothing. And the rich might not like it if the poor revolted, the French Revolution for example. There are other problems that are caused by “selfishness” of individuals in the free market as well. The market economy, as seen in history causes a wide gap or disparity between groups of people in the country. Massive wealth is held by a few and this small group get richer because one needs wealth to generate more wealth.
It is inherited wealth, earning high incomes from the sales of the factors of production that they own (renting land and making profit and interest from capital). Of course, in this system, if you have nothing and you do not have marketable labour skills (for most people this will be a good education), then you will remain poor. The market mechanism may also, seriously undermine consumers’ welfare. As producers are profit motivated – they will only produce for the rich – people who can afford to pay. Those with more money will be able to consume more of the goods produced.
Thus, food, housing, medical services and even ordinary goods will not be adequately produced for the poor. Especially, in the case of merit goods, the market will not produce at the social optimum level. Profit motivated producers would only produce education for those who can pay. If you start life with very little, and do not even get a good education, then there will be very little protection from destitution. Now, take the case of public goods. No producers would want to produce goods, which are unable to be charged for, for example, Infrastructure, street lightning and Lumpini Park. Hence, there is a shortage of public goods.
In the case of negative externality, private consumers and producers would generate the social costs of pollution, congestion and environmental damage for their own interests. For instance, in the west part of Thailand, profit motivated producers cut down the forest to obtain woods for sell so that they would earn revenue. This could lead to economic catastrophe in the long term because of the effects of global warming. This would not only effect to people in this generation but also to the people in the next generations. Nevertheless, “selfish” interests of each individual also “help” others in the society accidentally.
These followings are examples: Take the case of BP, the producers of BP also shows their environmental caring as they announced that they have already lowered their emissions by 10%, and they also said that they are planning to implement ISO14001. Showing their environmental caring is not because they are actually care the environment, but it is because they would like to create brand image, which is one of the ways to attract consumers. If you have been to Pinklao road, you would have seen the over crossing in front of the Merry king department store, which is built privately by the department store.
The over crossing, which is a public good, is not built because of public concern by the Merry king department store, but it is built because this would make it easier for customers to go inside the department store. In most of the restaurant, like Pizza Company, when you go to pay the bill at the counter, you would see a small box where you can donate to poor children. The Pizza firms do this is not because they want to help poor children, but they do this to show their concern to society. It is not always that starting life with very little will get little protection from destitution.
For people who inherited nothing, their wealth may come from the successful sale of their labour services. David Beckham came from nothing, but he is able to sell his labour services (kicking a football! ) for tens of thousands of pounds a week! Here is another example, which is widely known in Thailand. Mr. Taksin Shinawatra, the Prime Minister of Thailand who was one of the poor, now he is one of the wealthiest men in Thailand. However, although a market were efficient if it is run by “selfishness” of individuals, it would not necessarily lead to a social desirable distribution of resources between individuals.
Both efficiency and equity contribute to the level of economic welfare. For instance, the efficiency exists when an economy operates on its production possibility frontier. But there are an infinite number of points on the frontier. Which is the one which is most desirable? That question cannot be answered without some view about the distribution of resources within an economy. Most would agree that an economy where one person enjoyed 99 per cent of the resources whilst the other 100 million people were left with 1 per cent would be unlikely to provide a higher level of welfare than one where the distribution of resources was more equal.
Most (but not all) would agree that it is unacceptable to allow people to die of hunger the streets. The question of what distribution is desirable or is judged to maximise total welfare is a value judgement. Perhaps the most wonderful thing about optimisation is that it yields efficient outcomes without any sort of government control. It relies entirely on the decisions of ordinary people, who rationally balance off the benefits and costs of alternative decisions and selfishly choose the one alternative that adds most to their personal welfare.
People do not have to be commanded, cajoled, or persuaded to behave marginally. It is an innate, inherent drive of humans (and, some evidence suggests, of other species as well). We all seem to want to accomplish the most with the least, and we do this incrementally. According to the statement above, it satisfies the Smith’s economic view that if all economic agents pursue their own self-interest the result will be an allocation of resources which would simultaneously help society and create the greatest wealth for the greatest number of people in that society. He referred to this as the invisible hand of the market.