The concept of private property is central to the market economy, because it gives owners the right to sell their goods. Competition is also an important factor, because it affects supply and demand. In contrast to a market economy, in a command economy, a central government (or even a single ruler) decides how many goods should be produced and services provided, and sets their prices. Market economies are not controlled by a central authority such as a government, and are instead based on voluntary exchange. Market economies are a type of capitalism—an economic system in which private entities or people own the means of production. Conversely, command economies are tied to socialism and communism, where the collective group owns the means of production.
Examples of a Market Economy
Today, very few national economies are “pure” market economies or command economies. Most countries, including the U.S., have a mixed economy with elements of both market and command economies. Today, some sectors of the U.S. economy are highly regulated and directed by the government, and others operate with less government intervention. Because of this, the distinction between whether a country has a command economy or a market economy is less clear-cut. Economists today distinguish between many different types of market economies, based on how much a government intervenes in markets. In liberal market economies, for example, the competitive market is prevalent, as seen in the U.S. and the U.K. Coordinated market economies, on the other hand, exchange private information through non–market institutions such as unions and business associations. Germany and Japan use this model.
Characteristics of a Market Economy
A well-functioning market economy relies on a number of economic institutions, rights, freedoms, and conventions.
Private Ownership
In a market economy, most goods and services are privately owned. Owners can profit by selling or leasing property, products, or services.
Freedom of Choice
Owners are free to produce, sell, and purchase goods and services in a competitive market. They do have two factors that are somewhat outside of their control. First, a buyer must be willing to pay the price they set for their goods or services. Second, the amount of capital they have is determined by the costs to produce and sell their goods and the price they can sell them.
Motive of Self-Interest
Self-interest is one of the primary factors behind a successful market economy. Most businesses have been created for the best interests of the people that started them. A market economy provides opportunity, gives people a chance to work for themselves, and lets them try to earn a living in a way that they want to.
Competition
The force of competitive pressure keeps prices low. It also ensures that society provides goods and services more efficiently. As soon as demand increases for a particular item, prices rise thanks to the law of demand. Competitors see they can enhance their profit by producing the same item, adding to supply. That lowers prices to a level where only the best competitors remain. Competitive pressure also applies to workers and consumers. Employees vie with one another for the highest-paying jobs, and buyers compete for the best product at the lowest price.
A System of Markets and Prices
A market economy relies on an efficient market in which to sell goods and services. A market is said to be efficient when all buyers and sellers have equal access to the same information about prices, supply, and demand. As a result, price changes are pure reflections of the laws of supply and demand.
Limited Government
Even in a market economy, the government plays a role. It ensures that the markets are open, working, stable, fair, and safe. For example, many governments create regulatory agencies to ensure that products are safe for use and consumption, and that businesses are not taking advantage of consumers.
Alternatives to a Market Economy
Although most countries today have some form of market economy, this hasn’t always been the case, and there are a number of alternatives to this economic model. The economies of medieval Europe were feudal, for example, and anthropologists have discovered many different economic models among indigenous groups. For most of the last century, however, market economies have been understood in contrast to command economies. Cuba, North Korea, and the former Soviet Union all have or had command economies. China maintained a command economy until 1978, when it began its transition to a mixed economy that blends communist and capitalist elements. No economy today, except at the smallest scale, is a “pure” market economy. Almost all markets are regulated to some degree. This is because free markets can flourish only when governments protect individuals’ rights and support markets with proper infrastructure. A related concern is inequality. Recent studies have found that in contemporary market economies, the rate of return on investment frequently outstrips average growth across a society. Left unchecked, this phenomenon means the wealth held by owners of capital increases far more rapidly than other kinds of earnings (wages, for example). This process creates then deepens inequality.
Pros and Cons of a Market Economy
Pros Explained
Consumers and businesses drive supply and demand: Since a market economy allows the free interplay of supply and demand, it ensures that the most desired goods and services are produced. Consumers are willing to pay the highest price for the things they want the most. Businesses will aim to provide products and services that return a profit. Competition encourages efficiency: Goods and services are produced efficiently. The most productive companies will earn more than less productive ones. Innovation is rewarded with profits: Creative new products will meet the needs of consumers in better ways than existing goods and services. These cutting-edge technologies will spread to other competitors so they, too, can be more profitable. Businesses invest in one another: Successful businesses invest in other companies, which can help them succeed. That can lead to increased quality of production.
Cons Explained
Competition can be unfair and create inefficiency: The key mechanism of a market economy is competition. As a result, there is no inherent system to care for those at a competitive disadvantage. That includes older adults, children, and people with mental or physical disabilities that keep them from working.Not everyone can realize their full potential: The human resources of society may not be optimized. For example, children in lower-income families often work lower-income jobs to add to the family resources. If a market economy were concerned about progress rather than self-interest, these children might be afforded more opportunities for education and career choice.Can create and deepen inequality: Society reflects the values of the winners in the market economy. A market economy may produce private jets for some people, while others have no food or homes. A society based on a pure market economy must decide whether and how it should care for the vulnerable.
