Muhammad Usama

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FREE MARKET Prepared by: Muhammad Usama

FREE MARKETFREE MARKET is a system in which all the economics decisions are made by the producers, consumers and owners of the factors of production.

CHARACTERISTICS(a) PRIVATE OWNERSHIP OF RESOURCES: In free market economy the private ownership of property is allowed. The people can own the property, they can increase their productive resources and even transfer then into their heirs after death. They can own land, houses, factories, cars, shops etc. this the main characteristic of free market economy.

PRICE MECHANISMPrice mechanism refers to the way in which prices act as signals to coordinate the economic activities of economic agents. In pure free market economy, the economics agent are producers, consumers and factors of production. They make their decisions according to the price signals.

CONSUMER SOVERIEGNTYA consumer is sovereign in free market economy. He can consume a product he wants. People have freedom to spend their money on the goods and services they like. It is the consumer who determines what the producer should produce. If consumer want piano ball pen, more piano ball pen will be produced.

PROFIT MOTIVEA free market economy functions on the basis of profit. Private producers allocate their scarce recourses because of the profit they expect to earn in the business. The investment is made in such a business which yields maximum profits. Increase in demand for commodity by the consumer will increase its price.

ECONOMIC FREEDOMEconomic freedom means the freedom of consumption, production and provision of services. A consumer is free to purchase which he wants. A producer can produce a product which he wants a and a factor of production can provide his factors services where ever he wants.

COMPETITION Free market economy places no restriction on the consumers and producers. So a large number of producers are engaged in the production of a commodity. This promotes competition among the producers which enhance the quality of the product and decreases its price.


Automatic workingThe free market economy works automatically through price mechanism. No external force is required to run the system. The price of a product determines what to produce, how to produce and for whom to produce. A consumer also makes his decision of consumption keeping in view the price of a product.

OPTIMUM UTILIZATION OF RESOURCES The resources are owned by the private people in free market economy, so they are optimally used for the production of goods and services. Inefficient allocation of resources destroys the personal resources of the people. Hence a producer utilises his resources efficiently.

Innovation and developmentSince there are large number of producers in free market economy, the price of the product becomes uniform. To maximise the profit, producers is bound to reduce his productive costs. This can only be happened with the help of innovation.

ADAPTABILITYThe decision making in free market economy is easy. The private producers, consumers and factors of production act quickly according to the environment. For example, if a business is running into losses, a producer will quickly shift his capital into another business.

INCENTIVE TO WORKProfit motive is free market provides incentive to work. People work hard to get maximum profit. They know that if they do not work, they will lose their resources and profit.


Existence of monopoliesPrivate ownership of resources in free market economy leads towards monopolies. The people who own resources have more opportunities to earn more income whereas the people who are born with less resources have lesser opportunities to earn. This divides the society into haves and have-nots.

Uneven distribution of wealthUnequal distribution of wealth is the major draw-back of free market economy. The private people use their resources for profit maximization. The people who own the resources have maximum opportunities while the people who do not own sufficient resources have limited opportunities to earn wealth.

NEGATIVE EXTERNALITIESNegative externalities are the negative spillover effect of economic activities, e.g. pollution. Since the private producer allocate his resources to maximise his private profit, the production of negative externalities increase.

UNDER-PROVISION OF MERIT GOODS:Merit good is one which is under provided by the market economy. The reasons of under provision are the time and significant positive externalities e.g. health, education etc. Government also interferes in the system to provide such merit goods.

NON-PROVISION OF PUBLIC GOODSPublic goods are those goods who benefit cannot be restricted to a particular consumer. Consumption of public goods is non-rivalrous, meaning that consumption by one person does not deprive others of the goods e.g. defence, justice, police services and street lights.

WASTEFUL COMPETITIONA large numbers of producers in free market economy are competing to sell their product. To maximise sales revenue they use print and electronic media and waste their resources. This increases the cost of the production which ultimately puts burden on the consumer in the shape of increased prices.