Mixed Economy

The Three Economic Questions

Economics, for all intents and purposes, is the science of decision making. Since allocation of scarce resources
has been a polemic issue, an entrepreneur or an economist must answer the three fundamental economic
questions:
1. What to Produce?
2. How to Produce?
3. For Whom to Produce?
What to produce?
All productions must decide what to goods and/or services they should produce given only limited
resources.
How to produce?
There are number of ways to produce a product of equal quality. However, it is important to have a clear
grasp of all your alternatives.
For Whom to produce?
All productions are made for somebody to consume. In a free market, who gets what is determined by who
is able to afford what at a price determined by supply and demand.
The Invisible Hand Theory
The Invisible Hand Theory is a market force that helps the demand and supply of goods in a market to reach
equilibrium automatically.
Invisible Hand Theory introduced by Adam Smith in his book The Wealth of Nations (1776).
 It is a market force that helps the demand and supply of goods in a market to reach equilibrium
automatically.
 An economy will reasonably function well if the government will let the people buy and sell freely
among themselves.
 When there are no restrictions imposed by the government, charge and prices would be les, attracting
more customers and generating more sales.
 Therefore, competitors would lower their prices or offer something better.
 When sufficient people demand something, it will be supplied by the market.
 The seller end up gaining the price and the buyer will secure goods at the desired price.
 If all people are their own self-interest, everyone would work harder, persevere more, operate more, and
everybody would gain from it.
A business tycoon would offer a series of high-quality product line with the intention of generating better sales
outcome. Through what he publicly wants is to meet the demand of the consumers for a quality product
produced, what he really intended to is to gain more profits.
Price Mechanism
The price mechanism describes the means by which decisions taken by consumers and businesses interact to
determine the allocation of scarce resources between competing uses. This plays three important functions in a
market.
Signaling Purpose
 Prices perform a signaling function-they vary to demonstrate where resources are required and not.
 When prices fluctuate, we could determine whether it reflects scarcity or surplus.
 If prices are rising because of high demand from consumers, this is a signal to suppliers to expand
production.
  If there is an excess supply in the market the price mechanism will help to eliminate the surplus of good
by allowing the market price to fall.
Change of Preferences
 Producers are able to gather information about the changing nature of wants and needs through
consumer choices.
 Higher prices act as an incentive to raise output because the supplier will take advantage of making a
better profit.
Measuring Functions
 Prices serve to measure scarce resources when demand in a market exceeds supply.
 When there is a shortage, the price is bid up-leaving only those willingness and ability to pay purchase
the product.
Competition, Trust, Equity, and Efficiency
 To allow price mechanism work, there should be competing entities in the industry. It markets would
not be competitive enough, then the price system would not work justly and the invisible hand
becomes more obscured.
 Aside from competition, there must also trust. Creditors anticipate that the debtors will pay them on
time.
 Thus, although all businesses guard themselves against fraud and theft, they still transact with people
with the belief they would not commit it; and because of that conviction, businesses flow efficiently.
 The price system determined the answer to the three basic questions. Most economic agents should
settle that this would lead to a very efficient distribution of resources.
 The reasons for efficiency is to have the government stimulate the people to work hard, earn and
save.
 The basis for equity, then again, is to tax away a portion of the money earned by the rich ones and
relocate it to the poor.
Circular Flow Diagram
 The circular flow diagram is a model used to show how economy functions. It displays the
relationship of resources and money between firms and household.
 Firms employ workers who spend their income on goods produced by the firms. This money is then
used to compensate the workers and buy raw materials to make the goods.
 The good market is where all products made by business/firms are exchanged. The factors market is
where inputs such as land, labor, capital and other resources are exchanged.
 Household consume the goods offered by the firms. However, households also extend firms factors
so that they could produce products for the household consumption.
 Households also offer capital, which is a financial form of investing that helps firms create products.
 The main function of the firms is to offer goods. In order to do this, firms take the factors from
households and convert it into goods and services that consumers need.
The Economic Role of Government
The economic role of government can best be explained by taxonomy of its economic policy aims. The
government influences economic activity through two approaches;
1. Monetary Policy- where the government regulates the money supply and level of interest rates of
various actions that decrease or increase the money supply and raise or lower short-term interest rates
making it harder or easier to borrow money.
 2. Fiscal Policy- It uses its power to tax and to spend which determines in increasing/decreasing the total
supply of money in the economy.
Market Failure
Market Failure- is a status quo where the private sector cannot able to allocate efficiently by our resources by
means by using price mechanism or when the operation of market forces lead to a welfare loss.
 Complete market failure happens when markets does not supply product at all; while partial market
failure happens when market functions but it produces the wrong quantity of a product at the wrong
price.
 Markets can fail for lots of reasons. Be it externalities, environmental pollution, and lack of goods and
services that are needed to meets people’s needs and wants.
Government Failure
Government Failure- is a condition where the government has failed to allocate resources was unable to meet
their objectives.
 Even with worthy intents, governments rarely get their policy application correct. They can tax, control
and regulate but the outcome may be developing of market failure.
 It may range from minor problems where intervention is merely ineffective to cases where produces new
and more serious.

Causes of Market Failures

1. Conflict of Interest: The chase of self- interest between politicians and civil servants may lead to a
misallocation of resources.
2. Policy Myopia- Politicians has that tendency to look for short term solutions rather making considered
analysis of long term considerations.
3. Regulatory Capture- Industries under the control of a regulatory body operates in favor of the interest
of producers rather than consumers.
Economics System
Economics System- define how market entities and market forces interact.
Four Types of Economic Systems in the World
1. Capitalism- is an economic where private ownership and control is allowed in accord with their own
interest and maximize its profits base on its discretion.
 Individuals are motivated to produce because of the desire to generate profit. Government power is kept
at the minimum only at the level of guiding for peace, justice, and tolerable taxes.
 Pure Capitalism, also known as laissez-faire capitalism, the government’s role is restricted to providing
and enforcing the rules of law by which the economy operates, but it does not interfere with market.
2. Communism- is an economic and social system in which there is no private property.
 All property and resources are collectively owned by the state and not by individual citizens.
 According to the two geographers Karl Marx and Friedrich Engels, it envisaged common ownership of
all land and capital and withering away of the coercive power of the state.
3. Fascism- is an economic and government system led by a dictator, where private ownership of the
means of production exist but the government has strong centralized power for planning.
 Unlike communism, fascism is opposed to state ownership of the means of capital and economic
equality is not a principle or goal.
4. Socialism- is an economic and political system that pursues to reallocate the wealth more equitably by the
collective ownership of natural resources and major industries, such as public utilities.
 It highlights equality than success, and values labors by the amount of value they produce.
 However, unlike communism, most small or extra entities would remain privately owned and socialist
do not advocate violence or force to achieve their economic system.