Microecononics

John Manje 14/02037

Assignment 2

Question 1

i) Characteristics of a Capitalist Economy

(i) It is an economic system in which each individual in his capacity as a consumer, producer and resource owner is engaged in economic activity with a great degree of economic freedom.

(ii) The main motive behind the working of the capitalist system is the profit motive. The entrepreneurs initiate production with a view to maximize profits.

(iii) Income is received in monetary form through the sale of services of the factors of production and fro: profits of private enterprise.

(iv) Capitalist economy is not planned, controlled or regulated by the government. In this system, economic decisions and activities are guided by price mechanism which operates automatically without any direction and control by the central authorities.

(v) Competition is the most important feature of the capitalist economy. It means the existence of large number of buyers and sellers in the market who are motivated by their self-interest but cannot influence market decisions by their individual actions.

Advantages

(i) Efficient allocation of resources: in theory, capitalism or the ‘invisible hand of the market’ ensures resources are distributed according to consumer preferences.

(ii) Efficient production: in a market system, firms have incentives to be productively efficient – cutting costs to improve competitiveness and productivity.

(iii) Dynamic efficiency: this is efficiency over time. Firms in a capitalist system need to respond to changes in consumer preferences and respond to new consumer trends.

(iv) Financial Incentives: evidence suggests that people work hardest when there is a personal financial incentive.

Disadvantages

(i) Income Inequality: because the capitalist system compensates people based on the work that they are able to do, and does not accord all work the same value, serious income disparities quickly arise.

(ii) Lower Employment Rates: In many socialist economic...