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FACULTY OF BUSINESS & MANAGEMENT

SEMESTER 3

BBEK1103

PRINCIPLES OF MICROECONOMICS

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BBEK1103PRINCIPLES OF MICROECONOMICS

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Table of Content Page Number

1.0 Introduction 2

1.1 Limited resources 2

1.2 Choice and Opportunities 2

1.3 Fundamental problems of Economy 2

1.3.1 What to Produce? 3

1.3.2 How should it be produced? 3

1.3.3 For whom should it be produced? 3

1.4 Economic systems in the world 3

1.4.1 Traditional Economic System 4

1.4.2 Free Market or Price System 4

1.4.3 Centrally-planned Economic System 5

1.4.4 Mixed Economy System 5

2.0 Comparison of two Economic systems 6

2.1 The Centrally-planned Economic of North Korea 6

2.1.1 How They Solve the Fundamental Problems of Economic 6

2.1.2 Strengths of Centrally-planned Economic System 7

2.1.3 The weaknesses of Centrally-planned Economic system. 8

2.2 The Free Market System of United State of America 9

2.2.1 How They Solve the Fundamental Problems of Economic 9

2.2.1.1 What to produce? 11

2.2.1.2 How should it be produced? 11

2.2.1.3For whom should it be produced? 11

2.2.2 Strengths of Free Market System 10

2.2.3 The weaknesses of Free Market System 11

3.0 Tables of Comparison 12

4.0 Conclusion 13

Reference 15


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1.0 Introduction What is economic?

Economic concerned with the efficient use of a scarce resources to achieve maximum

satisfaction of human wants. Therefore, we can summarize that economics is the study of how to

satisfy unlimited human wants with limited or scarce resource.

Before we go to the type of economic systems in the world, it is better for us to know some of

the concepts in economic. According to http://economicsonline.co.uk, some concepts that we

need to know are as below;

1.1 Limited resources

Resources are said to be limited in two ways; one as limited in physical quantity such as land and

the other one is limited as in use such as labor and machinery.

1.2 Choice and opportunity

Given that resources are limited, we have to make choices between alternatives we have. All

economic decisions involve making choices therefore leads to creating sacrifices. For example, ifwe have RM10 to spend for, so let say a new shirt will cost us RM10 and magazines are RM5

each, if we buy the new shirt, we will have loss of benefit that we would have been gained from

2 magazines.

1.3 Fundamental problems of Economy

According to Clayton (2008), there are three fundamental problems that we have to answer in

order for us to make choices. The three fundamental problems are as shown below;
http://economicsonline.co.uk/http://economicsonline.co.uk/http://economicsonline.co.uk/


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Figure 1 : Fundamental Problems in making choices

1.3.1 What to Produce?

The available resources can only produce limited quantity of goods and services. Therefore, the

society needs to determine what types of goods and services to be produced with limited

resources to maximize their satisfaction.

1.3.2 How should it be produced?

Goods and services must be produced at its optimum level with a minimum input without

sacrificing the quality of the goods and products produced. This is the rule of thumb of every

economic system.

1.3.3 For whom should it be produced?

After being produced, goods and services have to be distributed. Consumer goods will be

disseminated to consumers while capital goods to firms. For this purpose, a mechanism should


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be available. The three basic questions above are used in the economic systems that used in

every country.

1.4 Economic systems in the world

The economic systems are classified into four groups, namely as follows;

1.4.1 Traditional Economic System

Traditional Economic system is an economic where people do their things traditionally.

Traditional economies are said to be the primitive on undeveloped economic systems where tools

and techniques are seen as outdated. This economy system is influenced by human habits,

customs and religious belief. This happens because of the people in this economic system live

simple where most of the time, they depends on products of nature to meet the needs.

The features of traditional economic system according to Daily Tape;

i. There is no sharing of work in the community. Everyone has their own part of workto be done.

ii. The barter system is still used in daily trade in order to cater the need of life.iii. The process of production and distribution system is developed for custom or

tradition according to what the community wants and always does.

iv. Nature is the source of life and prosperity.1.4.2 Free Market or Price System

According to Dictionary.com, a free market system or price system is a system where pricesand wages are determined by unrestricted competition between businesses, without government

regulation orfear of monopolies. According to Economywatch.com, the features of free market

system are as below;

i. Government does not interfere in the business activities.


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ii. Producers are free to produce what they want, how much they want and for whomthey want to produce.

iii. Consumers are free to choose.iv. Prices are decided by the Price mechanism.

1.4.3 Centrally-planned Economic System

Dictionary.com explained that Centrally-planned economy is an economic system in which

economic decisions are made by the state or government rather that by the interaction between

consumers and businesses. Therefore, a centrally planned economy pursues to control what is

produced and how resources are distributed and used.

The features of Centrally-planned Economic according to Drahokoupil (2010);

i. All resources are wholly owned by the government.ii. Consumers and producers have no control of what to produce.iii. Government controls the rice of goods and services, the market forces are not allowed

to. Profit is not the main concern

1.4.4 Mixed Economy System

This type of economic system is commonly used in most of the countries all over the world

nowadays. According to Bradley (2010), this type of economic allows both government and

private sector have their roles in directing the economy. Mixed economic are said to overcomes

the disadvantages of both free market and centrally-planned economic.

The features of mixed economic according to Shaik (2010) are as below;

i. Public and private sector are both exist.ii. Government intervenes in regulation and prices, market and also in income

distribution.


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iii. Government and public sector are providing more to social objectives such as publictransport, communication, utilities etc.

iv. Government act as regulator rather that a business entity.

2.0 Comparison of two Economic systems

Above are the four types of economic system used around the world. In order to understand

more on centrally-planned economic system and free market system, I would like to compare

North Korea and United State of America.

2.1 The Centrally-planned Economic of North Korea

Like most of the countries which used centrally-planned economic system, the role of market

allocation in North Korea is very limited. With Gross Domestic Product (GDP) per capita of less

than $2,000, North Korea remains as one of the worlds poorest and least developed countries

compared to its neighbor South Korea, which is one of the largest economies in Asia.

2.1.1 How They Solve the Fundamental Problems of Economic

This phenomenon of economic status is closely related to how North Korea manages the

fundamental problems of economic. The government or the central planning authority decides all

the important activities. They choose and the choice is the principle of an economic activity. The

government has the Planning Authority to solve the fundamental problems of economic.

As discussed earlier, the problems of what, how and for whom to produce are decided by the

commission. They decide how much should be produces and which goods and services are to be

produced. The problem of how to produce is solved by choosing the method of production to be

adopted in the factories owned by the government. The problem of whom to produce solved by

deciding the compensation for various skills and compensation for other factors production. The

process can be summarized in Figure 2 below.


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Figure 2: How Centrally-planned / Command Economic manages the economy.

2.1.2 Strengths of Centrally-planned Economic System

According to Moynihan & Titley (2000) there are four main strengths of the centrally-planned

system. First, the government focuses more on equality. All private property is eliminated and

the government will distribute the goods equally. If done correctly, there should be no poverty in

North Korea and everyone should be equal in wealth. Second strength is, centrally-planned

economic is the emphasizing of social service where there will be equality in provision of health

care, education opportunities and food.

The third strength is the government capability of doing rapid change if facing major problems.

As government is the sole owner of the companies, if there is any need to be shifted into a

different area, there is no difficulty to change it quickly.

The final major strength is that the Centrally-planned economic is very stable. It is great on

mobilizing economic resources quickly and effectively even though it has to do in the large

scale. Massive projects can be executed easily, create great industrial power and attain to the

imperative social goals. Centrally-planned economic system is able to override self interest in

individual level and overcome the welfare of general population in order to achieve a superior

agreed-upon goal to the bigger society.


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2.1.3 The weaknesses of Centrally-planned Economic system.

Moniyhan & Titley (2000) mentioned that the rapid mobilization means centrally-planned

economy cut down other social needs. For example, workers are influenced on what jobs they

must do and sometimes the workers are discouraged to move. They dont even given the

incentive to work hard and as a result, many people work just hard enough to fill the production

quotas set by the central planning authority.

Secondly, the resources in the country will be wasted due to the misallocation. This can happen

because the central planning authority does not consider the law of demand and supply.

Because they cannot get the updated information of what goods and services need to produce,

they go for rationing instead. Furthermore, the prices are set by them, therefore, it cannot be used

in gathering information about consumers needs and thus cannot be used to measure or control

the demands.

Thirdly, this economic system is not good in promoting innovation. They focus more on

following orders and discouraged from making any independent decisions. The rewards for

individual initiative are very rare as each person is expected to perform a job according to the

economic decisions made by the central planning authority.

Fourth, the centrally-planned economic system requires a very large decision making

organization. It requires a lot of administrators to operate the system. Therefore, decisions only

made after consulting a number of people and needs a lot amount of paperwork. Thus, these

procedures make the decision making slower and increase the production costs.

Finally, the centrally-planned economic system is not flexible when it has to deal with minor

day-to-day problems. The government has a difficult time coping with it because the absolute

size of the bureaucracy discourages any small adjustment.


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2.2 The Free Market System of United State of America

As we know, in free economic system, individual and private sectors act in their own to answer

the fundamental problems of economy. Therefore, the central feature of the United States of

America (U.S) is the freedom given to private sector in making majority economic decisions

towards the direction and scale of what should U.S produce (Heritage.org on Economic freedom

of United States).

According to Anderson (2006), this is boosted by reasonably low levels of government

intervention. Nowadays, U.S has 29.6 million of small business, 30% of world millionaires, 40%

of world billionaires and 139 largest companies out of 500 companies in the world (As in Forbes,

2011).

2.2.1 How They Solve the Fundamental Problems of Economic

Figure 3: How Free Market system manages the economy.

From the figure 3 above, we can say that the market has the power to make decision. As we have

discussed the features of Free Market system in subtopic 1.4.2, we can say that every consumers


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and producers are capable to solve the fundamental problems of economic. Shaik (2010)

explained on how free market system solves the fundamental problems of economic as below;

2.2.1.1 What to produce?

In free market system, what to produce would be depends on the needs and wants of the

consumer. The consumer would prioritize on goods and services that give the utmost satisfaction

and the market willproduce according to the consumers preference.

2.2.1.2 How to produce?

This is solved by the producers who seek for profits. Their main objective is to maximize profit.

They will look into the needs of the consumers before producing the goods and services needed.

In order to maximize profit, producers would use the most efficient production techniques with

the minimum of production cost.

2.2.1.3 For whom to produce?

It is depends on purchasing power. Any individual that has purchasing power and willing to buywould have the opportunities to buy the goods and services offered.

2.2.2 Strengths of Free Market System

According to Clayton (2008), the one advantage of free market system is it always can adjust to

change. For example in the 70s when the U.S has oil (gasoline) shortage, the consumers reduced

their demand for large automobiles and increase in smaller yet more efficient in fuel

consumption vehicles. When everything went back to normal, consumers opt for large cars again

and so the producers of automobiles began making big cars again.

Secondly, free market system has great degree of individual freedom. Producers may produce

whatever they think sellable and decide to produce their products in most efficient manner while


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consumers in the other hand spends on goods and services they most preferred. As individuals,

they are free to make their own choice of where and when they want to work, whether they

should make further investment on their own education and training.

Thirdly, government has very low degree of interference in the market. Government only

intervenes in certain important concerns for example on national defense and protection of the

environment.

Lastly according to Clayton (2008), in free market system, the decision making are decentralized

unlike the Centrally-planned economic system, therefore everyone has a voice in the economy

runs and directs the scarce resources into the uses that consumers favor.

2.2.3 The weaknesses of Free Market System

There are some weaknesses or disadvantages pointed out by Clayton (2008). One is that free

economic system does not provide for basic needs for of everyone. Anyone who is not capable to

care for themselves would have difficulties in surviving.

Secondly, free market system also does not provide adequate of services that individuals value

most for example a system of justice, national defense and comprehensive health care. This is

why the government has to intervene in providing these services where individuals pay back with

taxes.

Lastly, according to Clayton (2008), there would be high volume of uncertainty that workers and

businesses face if there is change done. For example, employees would concern about

termination of jobs and in the other hand the employers are worried about business being taken

over by another company that provide better and hence lost their customers.


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3.0 Table of comparisons

Advantages

Centrally Planned Economic Free Market System Economic

- Capable of dramatic change in a shorttime.

- Many basic educations, public health,and others public services available at

little or no cost.

- Provide equality to everyone.

- Able to adjust to change gradually.- Individual freedom for everyone.- Lack of government interference.- Decentralized decision making- Incredible variety of goods and services- High degree of consumer satisfaction.

Disadvantages


- Does not meet wants and needs ofconsumers.

- Lack effective incentives to get peopleto work.

- Requires large bureaucracy, whichconsumes resources.

- Little flexibility to deal with minor day-to-day changes.

- New and different ideas arediscouraged, no room for individuality.

- Rewards only productive resources;does not provide for people that not

capable to take care themselves to

work.

- Workers and business face uncertaintyas a result of competition and change.

- Does not produce enough public goodssuch as defense, universal education, or

health care.

- Must guard against market failures.- -

Table 1: Advantages and disadvantages of Centrally-planned Economy and Free Market System

Economy.


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Fundamental Problems

of economic


What and how much to

produce?

Decided by central planning

authority, according to the

government decisions in order to

maximize the social welfare.

Decided by the price determined

by the supply and demand.

How to Produce? On labor incentive in order to

fulfill social welfare.

Based on profits and techniques

are depends on the cost of

production.

For whom to produce? Equally to everyone Anyone who have the purchasing

power. Unfortunately do not

consider poor people.

Table 2: How Centrally-planned Economy and Free Market System Economy solved the

fundamental problems of economic.

4.0 Conclusions

In my opinion, between the two, the free market economic system is better and more convincing

than the centrally-planned economic system. This is because the Centrally-planned economy

seems to be outdated and not suitable for prevailing society as they consider much about

freedom, innovation, motivation, satisfaction etc.

Taking former Soviet Union for example; the collapse of it central-planning economy system is

caused by the main two problems; one is the coordination problem and the other one is the

incentive problem.

The coordination problem was chain related to each production. The outputs of some industries

are inputs in others; therefore if there is any problem in any sectors, the other sectors would be


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infected. There was no price mechanism to provide incentives to eliminate the obstacles, as in

free market system.

The incentive problem in the other hand, while profit and losses indicate success and failure and

incentives is given to increase or decrease production in the free market system, the central

planning have no incentive to respond to product insufficiencies or oversupplies.

Furthermore, the centrally planned system also lacked of entrepreneurship. Thus, they cannot

make profits to provide for any innovation. What worse, as government owned the system, there

is no initiative to improve the product quality or techniques of production and therefore, the

workers are lack of motivation to be more innovative. This has brought the collapse of the

former Soviet Union where they become 15 separate nations on November 1991.

As for the free market system, actually there is no pure free market system practiced in the

worlds nowadays. United States for example, even their economic system is said the closest to

the free market system, there is still some intervention from the government in the case of the

national defense, public necessities, environment and health issues. In my opinion, as long as

there is government, there would be some intervention from them in order to make sure that the

economy of the country will always stable and profitable to all.

(2947 words)


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References

Anderson, Jack. ( 2006),"Tax Misery & Reform Index", Forbes, retrieved on 7th February 2013

athttp://members.forbes.com/global/2006/0522/032.html

Andrew Jabobs (October 14, 2012). "North Koreans See Few Gains Below Top Tier". The New

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http://www.nytimes.com/2012/10/15/world/asia/north-koreans-say-life-has-not-improved.html

Brown, Betty J., Clow, John E., & Brown, Kenneth W. (1995). Introduction to Business. New

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Clayton G E.2008. EconomicsPrinciples and Practices. McGraw-Hill.

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