1. What is a market economy and why is it essential that government play a role
ID: 1147590 • Letter: 1
Question
1. What is a market economy and why is it essential that government play a role in such an economy?
2. The three primary forms of business are sole proprietorships, partnerships, and corporations. You are contemplating starting a business. For each of the following proposals, explain which of the three types of businesses would be most appropriate. In each case describe the advantages and disadvantages of your choice.
(a) You are a music lover and are disgusted with the selection of compact discs available at the stores near your college. So, you decide to open up a store selling new and used compact discs.
(b) After a late night cram session, you and your roommate are in need of some pizza, but no restaurants are open. You decide to open an all night pizza parlor.
(c) You have an idea that will make you a billionaire before you graduate from college: a pizza delivery service - from any restaurant to any dorm. In order to make your revenue goal a reality, a local venture capital firm has informed you that you will need to nationally franchise your operation.
Explanation / Answer
(1)
A market economy is characterized by free-market forces of demand and supply. In such a market there is no (or minimal) government intervention in day-to-day operations. The equilibrium price and equilibrium quantity purchased and sold are determined by equality of demand and supply, such that at the equilibrium price thus established, quantity purchased by consumers equal the quantity supplied by producers, and the market clears.
However, government intervention in a market economy is required in following cases:
(i) If there is a market failure, such as presence of positive or negative externality or information asymmetry, which results in the free-market equilibrium price and quantity being different from the socially efficient price and quantity.
(ii) The free-market price is too low, therefore government imposes a minimum (floor) price (set above equilibrium price), below which the good cannot be purchased and sold (such as minimum wage in labor market for workers or minimum support price in agricultural market for farmers), or
(ii) The free-market price is too high, therefore government imposes a maximum (ceiling) price (set below equilibrium price), above which the good cannot be purchased and sold (such as rent ceiling).
NOTE: As per Chegg Answering guideline, first question has been answered.
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