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Any merchandise for sale is composed of at least two factors of production. For any natural resource to be merchandise, it requires the input of human labor. Therefore, merchandise in a society means a combination of resources. Studying resource allocation in socialist society must start with the combination of resources in the form of merchandise.
The reason why one form of resource combination is preferred over another during a certain period of time in a society is ultimately determined by the needs and wants of human beings for particular merchandise. The way in which certain merchandise is supplied becomes a form of resource combination. This is a normal way of allocating resources. That is, demand guides supply as well as the combination of resources, which impacts resource allocation in a society and allows resources to be properly utilized. If the path is reversed, in which resource combination is determined in the first place, not only any product from the combinations of resources will fail to meet people's needs, resources will also be underutilized. As a result, resources will be utilized inappropriately as well as with low efficiency, and people's demand will be artificially suppressed.
This gives us a first look at the role of the market in resource allocation. That is, the market is an agent who determines resource combination. In research on resource allocation, market selection refers to the combination of various resources to produce various products to meet certain needs in a normal situation of resource allocation, in which the market serves as an agent to determine resource combination and functions as a bridge between demand and supply. For example, if the total quantity of overall resources is limited, there will be multiple ways of combining resources to produce different merchandise to meet various needs. If the market determines the combination of resources for production of merchandise to meet people's needs, ineffective usage or squandering of resources can be prevented, avoiding low utilization efficiency or suppressing demand.
As an agent that selects resource combinations, the market functions as if it were a large mixer, which constantly mixes various resources and churns out required combination (products). The mixing process is the determination of resource combination.
Of course, this is just a metaphor. In real life, certain amount of sand, stones, and cement in a mixer will gradually reach a state of even distribution during the mixing process. Comparing the market to a large mixer allows us to get a better understanding of resource allocation. As different resources are put into the large mixer and being constantly mixed, the mixer executes appropriate combination and produces all sorts of merchandise that meets various needs. The result of the mixing not only meets people's needs but also realizes effective resource allocation.
Market selection can be seen during the constant movement process as if the market were a large mixer. Market selection activities include economic activities such as market input decision, market output decision, and market distribution decision. Each and every decision is associated with the selection of resource combination. The activities of the market as a large mixer can be divided into three steps: production, sales, and distribution. These three steps happen to match market input decision, market output decision, and market distribution decision.
Market input decision refers to the decision of each market participant in terms of which resource is used in production, as well as its quantity, input ratio, and way of combination. Therefore, market input decision is a decision on the selection by each market participant of particular resource inputs and resource combination.
Market output decision refers to the decision made by each market participant with respect to where and how to produce certain outputs with certain inputs of resources. The output here mentioned refers to not only how each resource input can be turned into a physical product but also how a physical product can be exchanged for monetary income. Only after resource inputs are turned into monetary income through the production and sales processes can market conclude its input and output processes. Therefore, market output decision is a decision on how to turn a physical product into monetary income with certain combination of resources.
Market distribution decision refers to the decision on the distribution and usage of the monetary income generated from selling physical products. If such income is considered a resource, the next question is how to utilize it. If production, sales, and distribution are considered a continuous economic process, i.e., market input decision, market output decision, and market distribution decision are continuous decisions in a series of economic activities, then the distribution and usage of monetary income is as a matter of fact the initial allocation and usage of resource inputs.
Production is a continuous process. Monetary income will turn into consumption, savings, or investment via the market distribution decision. Each item of monetary expenditures is associated with the selection of resource combination. Consumption is associated with sales activities in the marketplace, which concerns market output decision. Savings and investment are associated with production activities in the marketplace, which concerns market input decision. All these expenditures are integral parts of market selection, which completes the selection process in the "large mixer," the market.
Market decision is made by each and every market participant(business or individual) according to their own economic interests. Dispersion is an immanent feature of market decision. More specifically, every business or individual decides on the quantity of resource inputs, how resources are combined, what physical products are produced, how products are sold to generate income, how income from selling products is distributed, and how many resources are redistributed as inputs. In terms of decisions on market input, market output, and market distribution, each separate decision made by each business and individual jointly forms the market decision on or the market selection of resource combination as well as the direction of resource allocation.
The dispersion of market decision indicates that market decision or market selection is composed of each and every unique decision or selection and there is not a predetermined market decision or market selection that leads to a decision for each business or individual. We should note that businesses and individuals have different goals and preferences. Their expectations of the market and profitability in the future also vary. Therefore, the selection or decision of the overall market is determined by the selection or decision made by the majority of businesses and individuals. When the majority of businesses and individuals have similar goals and preferences, with optimistic expectations of the market and profitability in the future and favoring higher input of resources, the selection or decision of the overall market will be expansionary or aggressive. As a result, the economy will grow. On the contrary, when the majority of businesses and individuals have similar goals and preferences, with pessimistic expectations of the market and profitability in the future and favoring lower input of resources, the selection or decision of the overall market will be contractive and conservative. Economic slowdown and recession will follow.
In an economic environment that is characterized by disperse market decisions, complete and free flow of information not only ensures every market participant is able to make decisions to the best of its interests but is also important in facilitating coordinated market activities. Complete information means that every business and individual has access to information on current resource combination and utilization available in society, which is equivalent to having full knowledge of the decisions or selections made by other businesses and individuals. Free flow of information means that access to information is prompt, fast, and inexpensive. If these conditions are met, different market decisions, in spite of being disperse, are still able to meet the requirement of realizing relatively effective resource allocation. If these conditions are met, disperse decisions will optimize the allocation of resources to the largest extent possible via the interplay between prices and supply and demand, even though there are constraints on supply (or resource supply constraints) or constraints on demand (or market constraints) which cause insufficient supply or demand.
That supply and demand in the marketplace influence price and price influences supply and demand demonstrates the function of the market in guiding the allocation of resources.
Market guidance is seen from the perspective of a dynamic equilibrium. The economic activities of the overall market can be divided into several stages. Supply and demand in the earlier stage not only determines the price in the current stage but also uses the price as an indicator to influence supply and demand in the next stage, signaling potential price changes as well as the magnitude of such changes. Potential price changes will in turn influence supply and demand as well as the price in the next stage. Various stages will go on and on, with the market providing guidance on resource utilization and combination in society as well as the possibility and method of turning potential resources into utilizable ones. We can come to the conclusion that what the market guides is the decision or selection of market participants.
Why does demand for certain resources gradually decrease while that for other resources gradually increases? Why is one form of resource combination gradually replaced by another one? Why do resource inputs in one sector gradually transfer to another one? These questions can be illustrated by the dynamic role of market guidance.
When looking at the role of market guidance, should we emphasize absolute price level or relative price level? Both are important. The absolute price of certain resources determines the quantity of aggregate demand and supply; the ratios of the prices of various resources, or relative price levels, determine the combination of resources, the distribution of resources in different areas, and resource utilization efficiency.
Looking at market selection and market guidance mentioned above, we treat businesses and individuals as if they were the same. In reality, businesses and individuals often appear as opposite sides of the supply and demand relationship. When individuals provide businesses with resources, individuals are resource suppliers and businesses are resource recipients. When businesses provide individuals with resource combinations in the form of physical merchandise, businesses are resource suppliers and individuals are resource recipients. Therefore, we must analyze two types of market behavior, investment and consumption.