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The price mechanism will always allocate scarce resources efficiently for all goods and services in a market economy. Assess the validity of this statement made by an economist. [15]

This economics paper assesses whether the price mechanism will always allocate scarce resources efficiently for all goods and services in a market economy. 

On the one hand, it will indeed allocate scarce resources efficiently in economic theory, because of the workings of the price mechanism to achieve productive and allocative efficiency. On the other hand, the allocation of scarce resources may not always be efficient, especially when there are market failures, which distort the workings of the free market.

On the one hand, the price mechanism allocates scarce resources efficiently in the market economy for goods and services through its signalling, rationing, allocating, and incentive functions. The signaling function is one where the price of a good allows for a re-calibration of the quantity demanded and quantity supplied, allowing goods to be efficiently allocated. Under the market price, consumers seek to maximise utility, and will therefore only consume if they are able to have a positive net benefit from the consumption of these goods. Those who are willing and able to pay will obtain the good. Correspondingly, the resources used to produce these goods will also be efficiently allocated, as producers maximise their profits by producing only if the cost of production is less than or equal to the prevailing market price. As a result, there is productive efficiency, since goods will be produced at the lowest cost combination to ensure profits are maximised. On the whole, there is also allocative efficiency, since society’s welfare is maximised, where only those who are able to consume and produce do so. 

Question: What economics diagram do you think should be drawn here? How would this diagram back up your arguments? 

On the other hand, there are market failures in the real world, which may impede the efficient allocation of scarce resources in a theoretical free market. Market failure is the situation where the free market fails to allocate resources effectively, and there is allocative inefficiency. There are many types of market failure, such as the lack of provision of public goods, under-consumption of merit goods but the over-consumption of demerit goods, externalities both positive and negative and also in consumption and production, imperfect competition, imperfect information, factor immobility, and inequality. 

Here, we focus on the under-consumption of merit goods. Because rational consumers seek to maximise their own welfare, they do not account for the positive externalities associated with the consumption of the merit good. Externalities are defined as the spillover effects to third parties who are not involved in the production or consumption of the good. Vaccinations provided for example by the National Health Service (NHS) are examples of merit goods. However, an individual consumer only considers his private benefit from getting vaccinated, and does not consider the positive externalities his vaccination confers on society. This results in an under-consumption of the merit good of vaccination, and there is therefore dead-weight loss, as society’s welfare has yet to be maximized due to this under-consumption.

Question: What economics diagram do you think should be drawn here to support the merit good argument, which shows that markets do not always work efficiently?

In conclusion, while the price mechanism allocates scarce resources efficiently in theory, this may not be the case in reality, as there are market failures that challenge the assumptions upon which the efficiency of the price mechanism is predicated. In the real world, with market failures, there is the need for government intervention in the free market to reduce or eliminate market failures so that the free market can produce the optimal outcomes the economists promise. 

Economics Tutor's Comment - This is a rather strong economics essay which covers quite a few important points and arguments, but it could do so much more. The candidate's use of economic theory is quite strong in this economics essay. Could more examples have been used, or could the example of the NHS have been even better utilised to make the point? Perhaps another market failure - the lack of provision of national defence - would have also been brought in to buttress the arguments. What else would make this economics essay even better than it is currently? Thank you for reading and cheers!  

JC Economics Essays - This economics essays site helps economics students with the A-Levels Economics (Cambridge, A1/S, A2, H1/H2 levels), and the international AS level economics examinations. This blog provides a range of useful economics content, materials, tips and techniques, and model economics essays that students in the United Kingdom, and also in countries such as Malaysia and Singapore, can use to excel in their studies and examinations.

This model essay was contributed by WT, our resident expert who helps students understand the beauty of Economics and provides content on economic issues. WT has a wide-ranging interest in Econometrics, Economic History, International Trade, and Game Theory, especially applications to real life. And as always, S. S., the editor of JC Economics Essays, edited this economics essay. He also provided comments for this essay. 

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