Why Do Some People Believe That the Market System Is the Best Mechanism for Allocating Scarce Resources and Thereby Encouraging a Positive 'investment Climate'? Explain Your Reasoning

The market economy or laissez-faire system is one which relies on the forces of demand and supply to determine the allocation of scarce resources and price. There is little or no government intervention in this system. This system promotes a positive investment climate as it allows the freedom of the firm in its decision making process to fulfil the needs and wants of the economy and does not breed a high level of bureaucracy in entering the market.

In a perfect world, the 'invisible hand' leads to complete efficiency and an optimal distribution of a country's resources. This would only happen in a state of equilibrium or when demand equals supply and there is a unique price for every commodity in question. In reality, however, prices are never at equilibrium and very volatile but are always attempting to arrive at this equilibrium position. The chart below describes the equilibrium position attained when demand equals supply.

Diagram 1

The market system encourages investment since, in continuously attempting to achieve an equilibrium price, firms enter and leave the industry. In an excess demand situation, firms can enter a market to meet this surplus demand and in an excess supply situation, firms can leave the industry or diversify to meet the needs of the market. A great variety of consumer goods become available for those who can afford them and this provides one of the greatest benefits to consumers - choice.

In the market system, buyers are free to buy any commodity in any quantity while the producer can produce any product they want to, depending on the indicators in the market. Producers are free to undertake the risks and gain rewards associated with increases in production and there is no state intervention in the functioning of the market. The market economy determines a unique price by demand and supply forces, in absence of any monopolistic or oligopolistic influences. The decision of what to produce, for whom to produce and in what quantities is taken by the market forces and not determined by the state. This system will therefore encourage all types of businesses to enter an economy so long as the market will allow it. Investors are attracted to this market as it allows them the flexibility to adjust as the market signals.

The role of the state in a market economy is limited to ensuring proper transparency in the prices charged by the sellers and the provision of infrastructure. This makes entering an industry simple since there are little or no bureaucratic barriers preventing such entry. The size, power, and cost of the state bureaucracy are correspondingly reduced as various activities that are usually associated with the public sector are taken over by private enterprises. The decisions of which industries prevail in the economy are made by the market and not by political drivers. This means that there is no

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