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2281 · 2.1

The market system — practice questions

Practice and worked examples for 2281 The market system. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

Compare how a market economy and a planned economy would respond to rising demand for electric vehicles.

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Market economy: Higher consumer demand shifts demand right → price rises → profit incentive attracts firms → supply expands; resources (labour, capital) reallocate via price signals. Firms that fail to adapt lose market share.

Planned economy: Central planners may set EV production quotas, allocate steel and battery inputs, and direct state factories. Response may be slower if planners lack local information; quality and variety may be limited.

Evaluation: Markets adjust quickly but may ignore pollution externalities (→ 3.1). Planners can prioritise long-term goals but risk inefficiency and lack of consumer sovereignty.

Worked example 2

A firm in a mixed economy can use its resources to produce either 1,000 smartphones or 2,000 basic mobile phones per month. The market price for a smartphone is $300 and for a basic phone is $50. The total cost of production for either option is 200,000.200,000.

(a) Calculate the potential profit from producing each type of phone. (b) Which product will a profit-maximising firm choose to produce? (c) How might this decision differ in a planned economy where the state has mandated the production of 2,000 basic phones to ensure universal access?

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(a) Calculate Potential Profit

Step 1: Calculate revenue and profit for smartphones.

  • Total Revenue = Price × Quantity = 300×1,000=300 \times 1,000 = 300,000
  • Profit = Total Revenue - Total Cost = 300,000−300,000 - 200,000 = **100,000∗∗100,000**

Step 2: Calculate revenue and profit for basic phones.

  • Total Revenue = Price × Quantity = 50×2,000=50 \times 2,000 = 100,000
  • Profit = Total Revenue - Total Cost = 100,000−100,000 - 200,000 = -$100,000 (a loss)

(b) Decision in a Market System

A profit-maximising firm will choose to produce the smartphones, as this yields a profit of $100,000, whereas producing basic phones would result in a significant loss. The price mechanism signals that consumers value smartphones more highly (relative to their production cost), directing the firm's resources towards their production.

(c) Decision in a Planned System

In a planned economy, the profit motive is secondary or non-existent. If the central planning authority mandates the production of 2,000 basic phones to meet a social objective (e.g., universal communication), the state-owned firm would be directed to produce them, regardless of the financial loss. The resources are allocated by command to meet the state's targets, not by price signals from the market.

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