Economic Principles: Specialization, Production, and Market Systems
Specialization and Exchange
One of the ways in which more goods and services can be produced in the economy is through the process of specialization. This refers to the situation where individuals and firms, regions, and nations concentrate upon producing some specialized goods rather than others. Specialization allows individuals (or countries) to specialize in what they are best at, and thus more goods and services will be produced.
However, no one is self-sufficient. It becomes necessary to exchange goods and services. When an individual or a country specializes, they will produce a surplus beyond their needs (which means they will have excess supply and will have to exchange it with other people or countries with a surplus of other goods or services).
Production Possibility Curves
How many goods and services an economy is capable of producing is determined by the quantity and quality of the resources available to it, together with the state of technical knowledge. These factors determine an economy’s production possibility.
Quantity + Quality of resources + technical knowledge = GOODS AND SERVICES
Example
An imaginary economy can produce either military or consumer goods. The graph shows all the possible combinations which could be produced. At point a, only military goods are produced, and at point d, only consumer goods. Between these two extremes lie all other possibilities.
Point Y represents a combination that can’t be achieved, perhaps because of a lack of technology.
The point X on the diagram represents a point where some resources are used inefficiently or are unemployed.
Shifts in the Possibility Curve
A production possibility curve is drawn on the assumption that the quantity and quality of resources and the state of technology are fixed.
Through time, economies gain and lose resources. Such changes will shift the production possibility to a new position. If the curve shifts outwards, it means that there has been economic growth. Causes:
- Increases in quantity
- Increases in quality
- Improvement in the state of technology
Causes in a decline or shift inward may be:
- Natural resources are exhausted
- Working population is falling
- Available technology has changed
Economic Structure
The term economic structure refers to the way in which the economy consists of various sectors. It is used to show the balance of economic activity.
- Primary sector = agriculture, fishing, etc.
- Secondary sector = Range of manufacturing activities
- Tertiary sector = Range of diverse activities
As an economy develops, the structure changes. There is a progression from primary to secondary to tertiary. In developed countries, the tertiary sector seems to be the principal employer, whilst in developing countries, similar proportions are employed in the primary sector.
Different Allocative Mechanisms
The problem of scarcity, which requires choices to be made, is common to all economies. These choices are determined by the economic system of a particular country.
The Market Economy
Decisions are taken by millions and thousands of firms and households. They interact as buyers and sellers in the market of goods and services. Prices act to indicate the likely market value of particular resources.
e.g.
- Short supply + high demand = high prices
- High supply + low demand = low prices
This is called the price system and plays the most important role in a market economy. On the other hand, the government has a very restricted part to play. It may:
- Control national defense
- Act against monopolies
- Issue money
- Raise taxes
It certainly should not try to influence the dealings of individuals in the market or to regulate the workings of that market.
The Command Economy
The government has a central role in all the decisions that are made. This is called centralization. In a command economy, it is central planners who determine the collective preferences of consumers and manufacturing enterprises, rather than the consumers. The key features of a command economy are:
- The allocation of resources
- Determination of production targets for all sectors
- Distribution of income
- Ownership of productive resources and property
- Planning the long-term growth of the economy
The outcome of the command economy is that central planning tends to set goals for the economy that differ from those of a market economy. In particular, they have a clear objective of achieving as high a rate of economic growth as possible. This economic system is most correctly described as one of sacrificing current consumption and standards of living in order to achieve enhanced future well-being.
In production possibility curves, the allocation of resources of the economic systems are clear. In a command economy, the government will choose to produce at X rather than at Y, because their intention is to increase the amount of capital goods rather than assure that consumer goods are satisfied in full.
The Mixed Economy
In the pure sense, these other two types of economic systems do not occur in reality. The mixed economy involves the interaction between government, businesses, and labor through the market mechanism. Private ownership of productive resources operate alongside public ownership. The government (to different extents in different countries) is responsible for:
- Substantial areas of public expenditure such as healthcare, education, and defense
- Nationalized industries such as coal, gas, water
- Providing support for large areas of manufacturing
There are times when government intervention is essential to equilibrate the price mechanism (Chapter 3). For example, there would be a massive under-consumption of merit goods and an over-provision of demerit goods.
Money: Its Functions and Characteristics
- Money is needed to satisfy our day-to-day needs. The money that we use for purchases is usually a national currency.
- It is anything that is regularly used to buy goods and services. Normally these are coins and notes, but it also includes checks, debit cards, and credit cards.
- Money must be portable and durable.
- It can also be in the form of a valuable commodity (gold or platinum).
- In some countries, there is hyperinflation and people lose confidence in money.
Before, there was a system of exchange of one good for another known as the Barter system. But it was impractical due to the in-coincidence of wants and was lengthy and difficult.
There are four essential functions of money:
- A medium of exchange. Money is the medium that buyers use for purchases (either physically or electronically)
- A unit of account. Prices are quoted in terms of common monetary units. It also allows different values to be added, measured, and compared. Where money is borrowed, then the lender requires interests.
- A standard for deferred payment. Not all payments we make are immediate. Some household bills are paid monthly or annually.
- A store of wealth. Money can be held or stored for a period of time before it is used. This means that money is a measure of value over time.