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What’s it: A market economy is an economic system in which market mechanisms determine economic activity. In other words, the economy is based on the power of supply and demand, where individuals and businesses take the central role in making economic decisions. There is no government intervention.
Businesses are free to produce, according to their respective abilities. They will always change and develop to meet the needs of society. They will strive to offer the highest possible price for the lowest possible quality. That way, they make the highest profit. But they can’t do it.
On the other hand, the individual (consumer) will want to buy the lowest possible price and the highest quality. That way, their satisfaction will be maximum. Still, they faced obstacles.
Since individuals and businesses have opposing goals, the market will solve them through the supply-and-demand mechanism. These two forces will determine the best price and quantity for companies and consumers. We call it the equilibrium point. The quantity supplied will equal the quantity demanded.
The market system is the opposite of a command economy, in which the government makes economic decisions and the allocation of resources. The government determines what goods and services are produced, how to produce them, and how to distribute them.
Market economy characteristics
Under the market economy system, individuals and companies play a significant role. Individuals control the factors of production. They need goods and services to satisfy their needs and wants.
On the other hand, businesses require production factors to produce goods and services. They then interact in the market, both the goods market and the factor market. This interaction ultimately determines the best price and quantity for both.
The market equilibrium forms the price and quantity of each good to be produced. Prices convey information about the relative demand for various goods and services and the relative costs of providing them. Price also provides an incentive to increase profits and lessen unprofitable activity.
The market economy allows the private sector to control economic resources. Market participants are free to produce, sell, and buy as they wish. They are not subject to government regulations that seek to limit economic activity.
Maximization of profits is a business motive when producing goods and services. They try to sell their products to the highest bidder.
Meanwhile, the maximization of satisfaction becomes an individual’s motive for consuming goods and services. They try to get the lowest possible price for the goods and services they need.
Competition exists between producers because each will try to offer the best to meet consumer needs. Such competition will ultimately keep prices fair and ensure efficient production and supply.
Furthermore, in a market economy, the government’s role is relatively limited and only to ensure that market mechanisms work. The government has a regulatory function to ensure fair competition and prevent anti-competitive behavior.
A pure market economy may be almost non-existent. Countries with economies close to market economic systems are the United States, the United Kingdom, Canada, and Denmark.
This system is more preferable among the more liberal societies, including the supporters of the free market. However, this system is less popular for people in several developing countries because it has several weaknesses.
Advantages and disadvantages of the market economy
Proponents of the market economy system argue that this system has many advantages.
The competition encourages efficiency in the production of goods and services. Besides that, it will also promote innovation, which keeps the market growing. As a result, the number and types of goods and services will be more numerous and more affordable.
People are motivated to work harder to keep their livelihoods and prevent job losses. Those who don’t will be eliminated.
The system also encourages entrepreneurship and new ventures. Because all individuals are competing with each other, they will try their best, either as workers or entrepreneurs.
Lastly, this system reduces the state bureaucracy. This is because some public sector activities are taken over by private entities
However, there are several drawbacks to the market economy system. The economic crisis is a common phenomenon along with the ebb and flow of business activities.
Because individuals compete with each other, there will be unemployment for the losers. Therefore, the unemployment rate will tend to be higher than the command economy, in which the state empowers the entire workforce.
The market economy system produces wider economic and social disparities. The distribution of the resulting income may be socially unacceptable.
Only a few people win the match and get prizes like a competition, the rest (more) don’t receive anything. Those who have capital are getting richer; on the other hand, those who are poor are increasingly falling into poverty.
The system also creates opportunities for labor exploitation. This is due to the pressure to win amidst high competition and the absence of government regulation.
Negative externalities are often overlooked. Each business will try to maximize its profits, whatever the means. They don’t need to treat the production waste because that will only increase costs. Companies can do this because there are no rules that limit this behavior.
In a pure market economy, markets can also be distorted by monopolies. If there is no government intervention, the winner of the competition can control the entire market. Since the motive is profit, they may adopt strategies that are detrimental to consumers, such as raising prices.
Finally, basic needs may be more challenging to provide because they are influenced by supply and demand.