Free markets are efficient
The free market is efficient in allocation of resources and also the determination of prevailing equilibrium price and quantity. There are some assumptions that underlie the free market and how it leads to efficiency. One of these assumptions is that the free market determines the optimal price and quantity to be produced, for this reason the market allocates appropriate value to resources and goods in the market, the other assumption is that the market is always at equilibrium in the long run, this means that when there is an increase in demand or supply or even changes in the prices then the market self adjusts to achieve a new equilibrium, for this reason therefore the government should not interfere with the free market because it efficiently adjusts itself to achieve equilibrium.
Many markets are efficient for example the cloth industry is one efficient free market where we have many firms in the industry and also many buyers where the demand and supply determine the equilibrium price that prevail in the market. An example of an inefficient free market is the market which leads to externalities, the mining industry lead to externalities where there are some negative externalities that occur, and this is the degradation of the environment whereby the market price does not cover all the costs of production.
Government taxes will earn revenue but at the same time lead to deadweight losses, some economists argue that labor taxes leas to the distortion of the market while some argue that government intervention is appropriate. The labor supply is one of the areas where economists disagree, some economists argue that supply creates its own demand while others argue that demand creates its own supply, this is the source of disagreement among scholars regarding government intervention.
The following diagram shows the deadweight loss as a result of government taxes in the market:
If we assume that the prevailing price in the market is Pe and an imposition of the tax will increase the price to P +t, then it is evident that evident that there is a reduction in consumer surplus, the consumer surplus is the area below the demand curve and above the prevailing price level, deadweight loss is the area market A in the chart. For this reason the tax will only distort the free market leading to deadweight loss.
A tariff is a form of trade restriction that involves the imposition of tax ion imports, this tariff will therefore reduce the quantity of goods that are imported because the prices of these goods increase, therefore the government earns revenue and there are less imports and therefore improved balance of trade.
Therefore there are various effects of these tariffs and they include increased government revenue, reduced imports and therefore favorable balance of trade and finally there is an increase in consumer prices because the tariff increases the final price of goods purchased by the consumers in the economy.
The GDP is the Gross domestic production, it is measured in different ways and this include the expenditure method and the income method, the expenditure method involves the addition of all the expenditure by consumers in an economy on final goods, the income method adds up all the income or reward to factors of production in the economy, for this reason my activities everyday affect the GDP level of the economy.
The GDP is an important measure in an economy because it helps determine the economic growth of a country; it also helps in comparing the economic performance between two periods of time for the same economy and also in the comparing two countries economic performance in a given period.
The activities that affect the GDP include my dairy expenditure on finished goods such as drinks, food and transport. However some activities do not affect the GDP level of the economy such as giving gifts to my friends.
The CPI is the consumer price index. It is an important index in that it helps in the determination of the inflation in an economy, however the substitution effect creates problems in the calculation of the CPI, the CPI calculation involves selection of some good which is referred to as the consumer basket which helps determine the cost of living, however consumers may substitute good due to high prices and this creates a problem, for example substitution of margarine for butter where butter may be less expensive and this will result into a biased estimate of the index.
Phillip Hardwick (2002) introduction to modern economics, McGraw Hill publishers, New York
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