We have already learned that every economy faces the economic problem of relative scarcity, which requires economic decisions that result in opportunity costs. These economic decisions will ultimately result in our scarce resources (or factors of production) being used (i.e. allocated) in a variety of different ways. Precisely how these resources are allocated in any nation will depend on what is considered to be the best or most efficient allocation of resources for that country and how much influence its government needs to have in the process of resource allocation.

Assume that a nation wants its government to have little or no influence on how the nation’s numerous resources will be used across the economy. This means that there is faith in the ability of the market to achieve the most efficient allocation of resources. In this economy, the goods and services produced will ultimately be determined by the wants and needs of consumers. Providing businesses can make a profit from producing these goods and services, a ‘market’ will develop, where buyers and sellers come together to exchange goods and services at an agreed price. In this context, ‘the market’ will determine how the nation’s resources are allocated. 

A market does not involve a single body or authority dictating the process. Instead it involves consumers and producers, guided primarily by self-interest, determining what goods and services will be produced, how these goods are produced and who gains access to or enjoyment of these goods and services.

In reality, no country allows ‘the market’ to solely determine the allocation of resources. This is because markets fail in many instances. This means that markets, left unregulated or without any form of government intervention, will lead to an undesirable (or inefficient) allocation of resources. For example, too many resources would be allocated to the production of goods and services that are not in the nation’s best interests (such as illicit drugs) and too few resources would be allocated to the production of beneficial goods and services that would otherwise be provided in insufficient quantities by ‘the market’. For example, merit goods or goods with positive externalities in production/consumption such as public parks, recreational spaces, education, health, etc.. [Refer to market failures]

The degree to which a country’s government intervenes in the operation of ‘the market’ will depend on the value system adopted by the government and its citizens. The more a government prevents the market from freely operating, the greater the degree of government planning that is required to determine how its resources (such as land, labour and machinery) will be used (allocated) in the economy. 

If we approach it from two extremes, countries such as North Korea and Cuba typically operate their economies towards the left of the continuum (planned socialism), whereas countries such as Australia and the USA operate towards the right of the continuum (market capitalism)