А market ekonomy

А MARKET EKONOMY.

 

Throughout history, every society has faced the fundamental economic problem of deciding what to produce, and for whom, in a world of limited resources. In the 20th century, two competing economic systems have provided very different answers: command economies directed by a centralized government, and market economies based on private enterprise. Today, in the last decade of the 20th century, it is clear that, for people throughout the world, the central, command economy model has failed to sustain economic growth, to achieve a measure of prosperity, or even to provide economic security for its citizens.

Yet for many, the fundamental principles and mechanisms of the alternative, a market economy, remain unfamiliar or misunderstood — despite its demonstrable successes in diverse societies from Western Europe to North America and Asia. In part, this is because the market economy is not an ideology, but a set of time-tested practices and institutions about how individuals and societies can live and prosper economically. Market economies are, by their very nature, decentralized, flexible, practical and changeable. The central fact about market economies is that there is no center. Indeed, one of the founding metaphors for the private marketplace is that of the "invisible hand."

Market economies may be practical, but they also rest upon the fundamental principle of individual freedom: freedom as a consumer to choose among competing products and services; freedom as a producer to start or expand a business and share its risks and rewards; freedom as a worker to choose a job or career, join a labor union or change employers.

It is this assertion of freedom, of risk and opportunity, which joins together modern market economies and political democracy.

Market economies are not without their inequities and abuses — many of them are serious — but it is also undeniable that modern private enterprise and entrepreneurial spirit, coupled with political democracy, offers the best prospect for preserving freedom and providing the widest avenues for economic growth and prosperity for all.

 

CONSUMERS IN A MARKET ECONOMY

 

Consumers in both market and command economies make many of the same kinds of decisions: they buy food, clothing, housing, transportation and entertainment up to the limits of their budgets, and wish they could afford to buy more. But consumers play a much more important role in the overall working of a market economy than they do in a command economy. In fact, market economies are sometimes described as systems of consumer sovereignty, because the day-to-day spending decisions by consumers determine, to a very large extent, what goods and services are produced in the economy. How does that happen?

 

Buying Oranges.

 

Suppose a family — Robert, Maria and their two children — go shopping to buy food for a family dinner. They may originally be planning to buy a chicken, tomatoes and oranges; but their plans will be strongly influenced by the market prices of those goods.

They may discover, for example, that the price of oranges has increased. There are several things that might cause those higher prices, such as freezing weather in areas where oranges are grown, which destroys a large part of the crop. The effect of the freeze is to leave the same number of consumers trying to buy a smaller number of oranges. At the old, lower, price, therefore, sellers would soon run out of oranges until the next harvest. Instead, by raising the price, all consumers are encouraged to cut back on the number of oranges they buy, and producers are encouraged to grow more oranges as fast as they can.

There is another possibility: suppliers could choose to import a larger number of oranges from other countries. International trade, when it is permitted to operate with relatively few barriers or import taxes (called tariffs), can give consumers wider choice and allow producers to offer more competitive prices for a wide range of products, from oranges to automobiles.

On the other hand, the orange crop might be spared freezing weather, but instead consumers decide to start buying more oranges and fewer apples. In other words, instead of the orange supply shrinking, demand increases. This too will drive up the price of oranges for a time, at least until growers have time to bring more oranges to market.

Whatever the reason for the higher price, Robert and Maria will probably respond in a predictable way once they discover that the price is higher than they anticipated. They may well decide to buy fewer oranges than they had planned, or to buy apples or some other fruit instead. Because many other consumers make the same choices, oranges won't disappear from store shelves entirely. But they will be more expensive, so only the people who are willing and able to pay more for them will continue to buy them. Shortly, as more people start buying apples and other fruits as substitutes for oranges, the prices of those fruits will rise as well.

But the response of consumers is only one side, the demand side, of the equation that determines the price of oranges. What happens on the other side, the supply side? A price increase for oranges sends out a signal to all fruit growers — people are paying more for fruit — which tells the growers it will pay to use more resources to grow fruit now than they did in the past. It will also pay the fruit growers to look for new locations for orchards where fruit isn't as likely to be damaged by bad weather. They may also pay biologists to look for new varieties of fruit that are more resistant to cold weather, insects and various plant diseases. Over time, all of these actions will increase the production of fruit, and bring prices back down. But this whole process depends first and foremost on the basic decision by consumers to spend some part of their income on oranges and other fruits.

    If consumers stop buying, or if they decide to spend less on a product — for whatever reason — prices will drop. If they buy more, increasing demand, the price will rise.

Keep in mind that this interaction of supply, demand and price takes place at every level of the economy, not just with consumer goods sold to the public. Consumption refers to intermediate goods as well — to the inputs that companies must purchase to provide their goods and services. The cost of these intermediate, or investment goods, will ripple throughout a market economy, changing the supply-and-demand equations at every level.

 

            Prices and Consumer Incomes

 

The other economic factor that consumers must consider carefully in making their purchases of goods and services is their own level of income. Most people earn their income from the work they perform, whether as physicians, carpenters, teachers, plumbers, assembly line workers, or clerks in retail stores. Some people also receive income by renting or selling land and other natural resources they own, as profit from a business or entrepreneurial venture, or from interest paid on their savings accounts or other investments.

We later describe how the prices for those kinds of payments are determined; but the important points here are that: 1) in a market economy, the basic resources used to make the goods and services that satisfy consumer demands are owned by private consumers and households; and 2) the payments, or incomes, that households receive for these productive resources rise and fall — and that fluctuation has a direct influence on the amount consumers are willing to spend for the goods and services they want, and, in turn, on the output levels of the firms which sell those products.

Consider, for example, a worker who has just retired, and as a result earns only about 60 percent of what she did while she was working. She will cut back on her purchases of many goods and services — especially those that were related to her job, such as transportation to and from work, and work clothes — but may increase spending on a few other kinds of products, such as books and recreational goods that require more leisure time to use, perhaps including travel to see new places and old friends.

If, as in many countries today, there are rapidly growing numbers of people reaching retirement age, those changing spending patterns will affect the overall market prices and output levels for these products, and for many others which retirees tend to use more than most people, such as health care services. In response, some businesses will decide to make more products and services geared toward the particular interests and concerns of retirees — as long as it is profitable for firms to produce them.

To summarize: whether consumers are young or old; male or female; rich, poor, or middle class; every dollar, peso, pound, franc, rupee, mark or yen they spend is a signal — a kind of economic vote telling producers what goods and services they want to see produced.

Consumer spending represents the basic source of demand for products sold in the marketplace, which is half of what determines the market prices for goods and services. The other half is based on decisions businesses make about what to produce and how to produce it.

 

Business in a market economy

 

As we have seen, a firm's success in a market economy depends on satisfying customers by producing the products they want, and selling those goods and services at prices that meet the competition they face from other businesses. Doing that requires firms to develop careful answers to one of the most important questions every economic system faces: how can a society produce goods and services most efficiently? In a market economy, that means getting the greatest value of output from the inputs producers use.

 

Production of bicycles.

 

Let's take the case of a firm that is considering the manufacture and sale of bicycles. Before launching such a venture, any entrepreneur or company has to consider a host of factors. First, what is the potential size and nature of consumer demand for a new brand of bicycle? Is there a single, large market for standard model bicycles? Or is the bicycle market divided in many smaller markets, or niches, for specialized bicycles for children, customized racing bikes or bicycles built for two? A new trend, such as the sudden popularity of so-called mountain bikes that can handle wilderness trails, might also attract new manufacturers who see an opportunity to make a profit. On the other hand, prospective suppliers may simply feel that they have developed innovative manufacturing techniques for a standard bicycle, or possess significantly lower labor costs, so that the company can undersell their rivals in the marketplace and still make a profit.

Not only are there many kinds of bikes to make, but there are many ways to make these bicycles — from using a highly automated assembly line to stamp out thousands of identical parts and put the bikes together, to using more labor and much less machinery to design and make customized bikes. Once again, the firm making these decisions in a market economy has to consider several different prices that may rise or fall in response to the behavior of people who buy and sell those products.

For example, the prices the firm has to pay for its inputs will obviously play a major role in determining how much steel, aluminum, labor, machinery and other materials the firm will use in making its bicycles. If the price of steel rises and the price of aluminum falls, many bicycle firms will look for ways to use more aluminum and less steel. Similarly, if wages for workers rise sharply, firms will have a strong incentive to look for ways to use more machinery, or capital, and less labor. A firm might decide to buy more fork lifts, for example, using fewer workers to move its inventory around the company's warehouses. Or it might use more machines to make routine and repetitive welds on its bikes, and thus hire fewer workers to do welding jobs. (As a consequence, the number of workers in factories producing the welding machinery used by the bicycle manufacturers would increase.)

Any such venture carries a large element of risk: a new bicycle design may fail to attract customers, or manufacturing costs may be unexpectedly high, pricing the company's bikes out of the market. Companies alone bear this risk of failure — and reap the economic rewards of success if they have planned correctly and their bicycle venture succeeds.

This balancing of risk and rewards by individuals and private companies points to an essential role of government in any market economy: protecting private property rights and enforcing a law of contracts. Property rights must be well-defined legally, and business owners and investors must be treated the same by the law and commercial regulations whether they are citizens of the country or foreign nationals.

Only if property rights are free from the threat of expropriation by government, or exploitation by political interests, will individuals and companies be willing to risk their money by investing in new or expanded businesses. Moreover, they must be assured that the state's legal system will settle disputes over contract terms in a fair and consistent manner.

In short, entrepreneurs, whether domestic or foreign, must be willing to face economic uncertainty in their ventures — but should not have to face political or legal uncertainty about the legitimacy of their enterprise.