Market Economy

A market economy (ME) refers to a form of economic system where businesses and consumers drive the economy with minimal government intervention. In other words, the laws of demand and supply determine the price and quantity of goods produced in an economy. It encourages entrepreneurship and results in greater production efficiency and consumer satisfaction.

Market economies are free economies or free markets where the extent of state intervention varies from minimum to moderate. Capitalist economies like the US come close to it. It is based on the idea that the profit motive of private businesses in trading would promote competition and innovation among companies and offer greater freedom of choice to consumers. As a result, economic efficiency improves, benefiting the entire economy.

• A market economy is a system where private individuals and businesses operate the economy on the basis of demand and supply without much state intervention.
• It increases economic efficiency and provides more independence to both businesses and customers, in turn promoting economic growth.
• Though the market economy positively impacts a nation's economy, the profit motive hampers social welfare.
• There are six major types of markets—perfect competition, monopoly, monopolistic competition, oligopoly, oligopsony, and monopsony.

The Market Economy is a market system where businesses independently produce goods and services based on their demand in the market. In this type of economy, all means of production are under the control and ownership of private entities or individuals. They are free to invest, produce, or trade as per their will without any government interference. Let’s see how it works.

When consumers purchase goods and services, it tells the economy their preferences. So, businesses try to produce more of such goods at the least possible cost to meet the demand. Since the profit motive primarily drives them, they try to charge the highest possible price. However, competition among sellers keeps the prices low.

As a result, the interaction of demand and supply establishes an equilibrium price for goods or services. As evident, consumers and businesses decide the price and the quantum of goods and services produced in such an economy.

Thus, the market forces of supply and demand, rather than the government, drive most of the activities in a Market Economy.  The range of government interference in a market economy differs. A 100% market economy will have no intervention from the government. However, that is possible only in theory. In real life, the government's role in such an economy is limited to:

• Providing equal opportunities for trading in the market to all
• Ensuring applicability of market rules equally
• Charging taxes on the market, businesses, and individuals for the welfare of people
• Regulating the market as per government policies

Furthermore, the Market Economy is based on the premise that the more the trade is conducted freely and fairly by individuals and businesses with a profit motive, the more it is beneficial to the nation’s economy.

As mentioned, the prices of goods or services directly depend on demand and supply. So, the scarcer a good or service is, the higher its demand and price. Therefore, demand and supply form the invisible hand responsible for the sustainability of the trade in the ME.

The concept of the invisible hand in economics was the brainchild of Adam Smith, which assumed that the selfish interest of businesses and individuals would lead to the betterment and sustainment of the economy. Also, without the invisible hand, the trade would collapse as:

• If the demand for goods or services increases without the rise in supply, the price increases.
• If an increase in demand does not follow the rise in supply, the price falls.

Hence, the invisible hand forms the backbone of the market-based economy.

In market economies, there are six major types of markets. They are as follows:

#1 - Perfect Competition

Perfect Competition is an ideal where:

• Every firm has the same products to sell
• The price of products is not influenced by market share
• New entrants do not face any barrier to entry into the market
• There is transparency in product information with the consumers
• The companies do not play any role in determining prices

#2 - Monopoly

It is a market system where there is no competition between sellers, and only one seller sells the product to the public.

#3 - Monopolistic Competition

In this case, numerous companies within a certain sector sell similar products that are not identical. As a result, these companies cannot control the prices of the products for their profits.

#4 - Oligopoly

Oligopoly market system has a few sellers of some unique products and cooperates with each other to control the market power in unison. As a result, the firms can collectively raise the price to profit.

#5 - Oligopsony

Oligopsony is a market system comprising a few powerful buyers and numerous sellers. It is usually seen in markets for inputs.

#6 - Monopsony

Monopsony is a market with only one buyer and multiple sellers. The buyer controls the market and obtains products at low prices.

The following market economy examples clarify the concept and applicability of ME to a great extent.

Example #1

The best example of a global market economy is the US. The US has a free market where buyers and sellers fully control the production and pricing. As a result, the supply and demand of a product determine the companies' investment and manufacturing decisions. Moreover, the government has minimal control over the market; thereby, the demand-supply mechanism promotes the exchange of products and services and protects consumers and sellers alike.

Example #2

Another best example is Great Britain. Great Britain was the front runner of the industrial revolution in the 19^th century. Therefore, its economy is completely driven by market forces. It is independent, highly developed, and internationally recognized for pro-market initiatives. There are no government policies affecting or controlling the market in any way. Here the buyers and sellers can make their own business decisions. The market regulations and pricing are due to the demand and supply mechanism. However, of late, politicians are pushing to steer the economy away from the free market system.

The following are some of the unique market economy features:

• Private ownership of property and business
• Freedom to consumers and business
• Selfish motive for profit
• Rivalry among businesses
• Miniscule government regulation

The market economy has its advantages and disadvantages like every other system. Here are some of them.

This article has been a guide to Market Economy & its Definition. Here we discuss market economy, its types, characteristics, advantages, disadvantages, and examples. You can learn more about accounting from the following articles –

• Developing Economy
• Knowledge Economy
• New Economy