SCARCITY, CHOICE AND THE ALLOCATION OF RESOURCES

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SCARCITY, CHOICE AND THE ALLOCATION OF RESOURCES The problem of scarcity means that choices have to be made and therefore we need to examine how these choices are made and therefore how in reality resources are allocated? INCENTIVES The answer to the question above all comes down to incentives and in particular the incentive of individuals, firms and the government to maximise. CONSUMERS - Individuals will choose products that maximise the utility that they gain from the products they consume. The choice of these products, and the changes in them, will affect the levels of profit that firms receive on individual products or services. FIRMS – Consumers therefore influence the behaviour of entrepreneurs and they change the products that they offer. This is because firms seek to maximise profit (their incentive) and therefore they will change what they offer in order to produce products that offer higher levels of profit. The products that will produce the highest levels of profit are the ones that are in greatest demand by consumers. WORKERS – What firms wish to produce will affect individual workers who seek to maximise the wages that they earn so that in turn they can maximise the utility that they gain from their consumption. As the types of products and services that firms offer change over time it will influence workers to alter the skills and abilities that they offer so that they can meet the requirements of the firm and therefore obtain higher wages as their services will be in greater demand. If they do not then their wages will fall as what they can offer is in less demand as it does not match what firms wish to produce. From this you can see that resources are allocated to meet the choices that consumers want. However this simple theory can be spoilt by the process of marketing. Clever marketing by firms can in reality influence what consumers actually want. PRICE

THE PRICE

MECHANISM

The price mechanism is the method by which resources are allocated in a market economy.

The key device to this system working is price. Prices act as indicators to the market and provide three functions in the allocation of resources:

1. High prices act as a SIGNAL to firms, showing them the goods and services that are in greatest demand by consumers. Prices adjust to show firms where resources are required.

2. High prices act as an INCENTIVE for firms to change what goods and services they offer (i.e. to act on the signal) as higher prices are likely to lead to higher profits for the firm.

3. High prices also have a RATIONING function, with the high prices meaning that the limited output is rationed to those that are willing an able to pay.