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Role of Enterprise in Market Economy with Increased Demand

Explain the role of the factor enterprise in allocating resources in a market economy when there is an increase in the demand for a good. Use a diagram to support your answer.

Category:

Market Structures and Competition

[CIE AS level May 2017]

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Answer

Tip: Remember to emphasize the aspect of enterprise in this essay.
E.g: ... as there is an increase in the demand for a good enterprise will commit more factors to the production of that good in the expectation of further profit.


Step ➊ : Define the 'free market' and explain the functions of enterprise in a free market economy. (Knowledge and understanding).


A market economy is an economic system in which production and prices are determined by the forces of demand and supply. There is an absence of government intervention.

Entrepreneurs carry out two functions in a market economy. First, the enterprise factor organises the other three factors of production which are, land, labour and capital. Second, enterprise involves taking the risk of production, which exists in a free enterprise economy. The return for enterprise is the profits that are made.

In this essay, we will explain the role of the factor enterprise in allocating resources in a market economy when there is an increase in the demand for a good.


Step ➋ : Explain how enterprise responds to an increase in the demand for a good. (application)


As there is an increase in the demand for a good enterprise will commit more factors to the production of that good in the expectation of further profit. This will be represented by a shift to the right of the demand curve leading to a higher price and a movement along the existing supply curve. The diagram below shows how enterprise responds to an increase in the demand for a good.

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An increase in the demand for a good will cause it’s demand curve to shift from D1 to D2 and prices to rise from P1 to P2. This will motivate the firm to increase supply and the quantity traded will increase from Q1 to Q2.

It should be noted that prices perform a signalling function in the free market, this means that they adjust to demonstrate where resources are required, and where they are not. If prices are rising because of high demand from consumers, this is a signal to entrepreneurs to expand production to meet the higher demand.

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Step ➌ : Conclude
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If there is a rise in the demand for a good in a market economy, it's price will rise. The factor enterprise will respond by expanding production in pursuit of more profit. The quantity of goods in the market will expand along the industry supply curve.

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Mark scheme ♕
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For knowledge and understanding of the role of the factor enterprise: For bearing the risk of production (Up to 2 marks)

For organising the other factors of production (Up to 2 marks)
(4 marks maximum)

For application: An accurate demand and supply diagram will show an increase in demand, a rise in price and an extension in supply. The diagram will have an accompanying explanation of how enterprise, motivated by profit, allocates more resources to the production of this good.

(4 marks maximum)

The factor enterprise has two roles in a market economy. One is taking the risk of production, the other is organising the other factors in the production process. The reward for contributing to production is profit. If there is a rise in the demand for a good in a market economy, its price will rise. The factor enterprise will respond by expanding production in pursuit of more profit. The quantity of goods in the market will expand along the industry supply curve.

An ‘accurate’ diagram will have axes and curves labelled correctly, the shift in the demand curve will be correct and there will be an extension in the quantity supplied. In awarding marks for application allow
Up to 3 marks for the diagram.

One mark should be reserved for an explanation of the role of enterprise in allocating resources to the production of the good.

Please note that some knowledge and understanding of the role of enterprise might be shown in the candidate’s explanation of how enterprise responds to an increase in the demand for a good. They might, for example explain how enterprise manages the other factors as the demand for a good increases.

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Examiner’s report ♕
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This was the least popular essay of the three options available. It was disappointing that so many candidates had limited knowledge of the role of enterprise in a market economy. There are two aspects to enterprise. One is that enterprise takes the risk of production. This means committing funds in pursuit of profit and accepting that this might mean making a loss. In addition, enterprise is the factor of production that organises the other factors, land, labour and capital, in the production process. As there is an increase in the demand for a good enterprise will commit more factors to the production of that good in the expectation of further profit. This will be represented by a shift to the right of the demand curve leading to a higher price and a movement along the existing supply curve. Many candidates made the mistake of providing a diagram with the correct demand curve shift but they also shifted the supply curve to the right. This gave an unknown impact upon the new equilibrium price. This was not given credit.

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