b) Discuss whether the price mechanism is an effective way to solve the basic economic problem (12m) The price

mechanism is the means by which consumers and businesses interact to determine the allocation of scarce resources between different goods and services. It acts as an invisible hand to control the price and quantity demanded of goods and services. For example, when prices increase, quantity demanded will decrease. This will eventually lead to the prices dropping again. Hence, equilibrium is restored. With the aid of the price mechanism, resources can be allocated efficiently. Producers will supply according to what the consumers want while producing it at the least possible cost. For example, if consumers demand more fishballs, the producers will produce more fishballs to increase revenue as demand is high. Simultaneously, the fishballs can be produced at a lower cost because according to the price mechanism, when quantity demanded increases, price reduces. Besides that, the quality of product will also be maintained. This is because goods and services that are not of good quality will not be demanded as highly as other goods with better quality. As an example, if the fishballs being sold are rotten, the consumers will not consume it as the price of fishballs are highly elastic. The price of fishballs will drop. Hence, the quantity demanded would increase. Competitors of this particular producer will then increase their output and maintain the quality of their product. However, if the price mechanism does not work, there will be market failure. This includes non-provision of public goods. This is due to the free rider problem where consumers consume goods and services without having to pay the producers anything. Hence, the producers have less incentive to produce public goods. For example, if producer A builds a lighthouse, other people can still use the lighthouse without having to pay producer A. Other than that, there is under provision of merit goods. Merit goods are a private good that society considers underconsumed, often with positive externalities. For example, education, healthcare and sports centers. These goods are under provided because they cost a lot more to produce than what is paid to consume it. The cost of providing healthcare including salary to doctors and nurses as well as building the building and maintaining it on top of getting equipment is much more than what is paid by the consumers to consume the healthcare service. Therefore, the producers have less ncentive to produce the merit goods. On the other hand, there is over provision of demerit goods. The goods such as cigarettes, cigars and alcohol that often cause negative externalities are often over provided because they cost less to produce than what is paid to consume it. This is because the demerit goods are highly inelastic in price. For instance, a packet of cigarettes may cost RM5 on the shelf but only cost RM3 to produce. Hence, producers have a higher incentive to produce them to increase profit. Since the disadvantages of price mechanism is much more than the advantages of price mechanism, it can be concluded that the price mechanism is not an effective way to solve the basic economic problem. Therefore, government intervention should be used on top of the price mechanism to solve the basic economic problems.