Part a-Economics and Society

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Features of a

“free market economy” is one in which most businesses are privately owned and where individual producers and consumers determine the kinds of goods and services produced as well as the prices of such products through a voluntary exchange of goods and services. Competition is a key factor in market economies as it keeps the prices of products in check, forces the competitors to enhance the efficiency of their production process, and drives the inefficient producers out of the market. Another important feature of a free market economy is that income is distributed largely through the operation of markets. (“Free Market Economy,” 2003)


Efficiency in economics is the absence of waste, expense, or unnecessary effort achieved primarily by gains in productivity resulting from specialization, the consequent division of labor and a system of exchange. An efficient economy utilizes all of its available resources in an optimum manner and produces the maximum amount of output that its technology permits.

Failure of Free Market Economy

Failure of markets occurs largely because an important pre-requisite of a free market economy, i.e., a ‘perfectly competitive market’ is largely a theoretical economic concept that does not exist in practice. Hence, market failures may occur due to imperfect competition that give rise to an inefficient allocation of resources; monopolistic markets in which there may be only one producer supplying a particular product or markets dominated by only a handful of major suppliers; and periodic ‘boom and bust’ cycles that are triggered by large-scale speculation in areas such as stock-markets, currency markets, and real-estate that lead to unsustainable ‘price bubbles.’ The government has a key role in preventing or correcting such market failures by enacting and enforcing anti-trust and other regulatory laws.

Part B-Applied Economics

What major Present Day Problems can be solved with the knowledge of economics?

Perhaps no other single field of knowledge impacts everyday lives as well as the well being (or otherwise) of the people as Economics. Almost every such as poverty, economic inequality, unemployment, inflation, and pollution; even terrorism can theoretically be solved by the application of economic theories.

Poverty, for example, is one of the most formidable challenges facing the economists and politicians in the 21st century. Rural poverty in the developing countries, in particular, has worsened in recent decades. The main reasons for this are falling commodity prices, dumping of competing goods from the developed countries at subsidized prices, trade barriers in the rich countries that deny market access to the poorest countries, that reflect a ‘rural bias’ and decreasing overseas development aid to poor countries. (“The Rural Poverty Trap,” 2004) All of these reasons can be tackled by adopting appropriate economic policies. Inequality is another major problem facing the present-day world. Unfortunately most growth oriented economic policies such as “supply-side” economic policies tend to exacerbate inequality. A greater role of the government in the economy such as increased taxation on the rich can reduce inequality. Inflation and unemployment are usually inversely proportional in most economies, i.e., increase of money supply through deficit financing reduces unemployment but increases inflation while tight monetary policies reduce inflation but increase unemployment. According to a number of analysts, a major cause of terrorism in the world is an acute sense of deprivation among a large section of the population. Economic measures can, arguably prove more effective in rooting out terrorism than military action.

Part C-Theory

What, How and for Whom to Produce:

In ‘free market economies’ decentralized decision making by individuals and firms based on consumers’ desires (which determine the price of goods) and the profit motive determine what goods are produced and in what quantities. For example, consumers in the present age value automobiles and the skills of auto mechanics more than horse-drawn carriages or blacksmiths, so they are likely to spend their money to buy cars and pay auto mechanics for their services rather than spend their money on horse-drawn carriages and the services of blacksmiths. Hence firms are likely to produce automobiles instead of horse-drawn carriages and people are likely to become mechanics rather than black smiths. (O’Connor and Faille, 2000) How goods are produced is decided by the firms basing their decision on increased efficiency to cut costs; the ‘for whom’ decision is largely governed by household incomes.

On the other hand in controlled markets, centralized decision makers in the government, or a the types of goods to produce. The government dictates how resources are to be utilized to satisfy society’s needs and also controls the wages and prices.

Most economists argue that free market economies are superior to controlled economies because free markets are more efficient; they encourage individual responsibility for decisions; the profit motive provides the strongest incentive to individuals and firms to allocate resources for their most productive use and to produce goods and services that the public wants, using the most efficient means of production. Controlled economies, contrastingly, suffer from inefficiency as centralized decisions about production and prices create artificial distortions in the economy and the lack of profit motive creates lethargy.


Free Market Economy” (2003). Article in Microsoft Encarta Encyclopedia. CD Rom Version, 2003.

O’Connor, D.E. & Faille, C. (2000). Basic Economic Principles: A Guide for Students. Westport, CT: Greenwood Press.

The Rural Poverty Trap.” (2004). Oxfam Briefing Paper # 59. [Available online] Accessed on January 26, 2005 at

According to FAO statistics more than 900 million people live on less than $1 a day in the rural areas of the developing world (The Rural Poverty Trap, 2004)