Characteristics of market economy


The Resources Needed to Create Wealth

What is needed to create wealth? Within the marketplace, there are many resources that go into the production (input) of goods and services. These resources can be grouped into four categories. These categories are land, labor, capital, and entrepreneurial ability.

The land category consists of not just land, but all natural resources, water and air. Labor is all the work that is performed by man. Capital is industrial machines and buildings, not financial capital (money is not capital by this definition). Finally, there is a special resource called entrepreneurial ability. It is the entrepreneur that organizes and arranges the use of land, labor, and capital to create an output demanded by the marketplace. It is the entrepreneur’s responsibility to decide on what amounts of each resource to use and then use those resources efficiently to create a product or service that is valued higher by the marketplace than the value of the resource inputs.

The Law All Entrepreneurs’ Must Understand

The second concept that is essential for all entrepreneurs to grasp is that of supply and demand. As the demand curve illustrates, when the price of widgets are high, say $9, none are demanded. However, when the price is low, say $2, the marketplace demands many. As we can see from the following graph, the market would demand about 12 widgets when the price is $2.

As we can see from the following graph, the market would demand about 12 widgets when the price is $2.

At a price of $2, twelve widgets will be bought. But would suppliers be willing to sell widgets for $2. Would they even make a profit at this price level? Let’s look at the supply curve to see what amounts producers of widgets would be willing to sell at each price level.

The supply graph illustrates that as the price the market is willing to pay for widgets increases, widget suppliers are willing to produce a greater quantity of widgets.

From the below graph, we can see that if the market was willing to pay $2, suppliers would be willing to produce 3 widgets.

This is a bit of a problem, however. If at $2 the market demands 12 widgets and only 3 are produced, they’ll be 9 people without widgets. There is a shortage in the marketplace. Widgets are scarce. Because those nine people know they will not get a widget unless they pay more, they bid up the price. A few of these nine people will not be willing to pay as much as they must to obtain a widget. A few of them will, however. This process eventually leads to an equilibrium price and quantity, where the suppliers produce exactly how many the market demands at a set price.

To determine this equilibrium price and quantity of widgets, let’s put the demand and the supply curves together on the same graph.

We have found the equilibrium price and level of output. This equilibrium point occurs where the supply and demand curves intersect. From this graph we can see that at a price of about $4.80 there will be 8 widgets demanded by the market place and 8 widgets supplied by producers.
Now, if demand increases, the price and quantity supplied will also increase. If supply increases, perhaps due to a new technological innovation, widgets will be less scarce and the price will go down and output will go up. These are the laws of supply and demand.

There are three important lessons which each entrepreneur has to know when he is starting his own business

Lesson One: How to Price Your Products

If you charge too much you may make a large per product profit but not make many sales. Vice versa, if you charge too little you may make many sales but little profit or perhaps a loss. You likely will not have the resources to hire a team of Ph.D’s to do elasticity and econometric studies to determine the exact point, but you can come close through trial and error meaning that to find the price that will maximize revenue, you will have to experiment. Test different price points and see what the reaction is on sales, total revenue, and net profit. Or you can set the price by seeing what your competitors are charging.