Economics - Resource Allocation in the Competitive Market
Resource Allocation in the Competitive Market
Resource allocation in a competitive market system is based on the
principle of consumer sovereignty. Consumer sovereignty is where consumers,
through their effective demand , determine the composition of output. In
other words, what consumers want, producers will supply.
Reallocation of resources begins in the product market (the market for a
good or service). If there is a change in the conditions of demand, for
example, an increase in disposable income, there will be an increase in
effective demand for the product. As a result, there will be an increase in
the derived demand  for the resources that make the product. The market
for the resources is known as the factor market. As the derived demand in
the factor market increases, price in the factor market will increase. As
price in the factor market is the reward for employing the resources
(profit), it signals to producers that producing more of the product can
make supernormal profit . As a result existing producers and new
producers will allocate more resources into this industry. Resources will,
therefore, be allocated away from areas with low consumer demand toward
areas of high consumer demand.
Many markets are related and what happens in one market can affect the
actions of buyers and sellers in other markets. There will be a structure
of relative prices established throughout the economy, which can be
affected by changes in related markets.
If demand increases for a product, as discussed before, it has the
potential to alter the allocation of resources in many associated markets.
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