What is a market economy?
A market economic system (also called a free‑market economy or capitalist system) is one in which most resources are owned and controlled by private individuals and firms. Decisions about what to produce, how to produce and for whom to produce are made through the price mechanism. Entrepreneurs seek to maximise profits and consumers seek to maximise satisfaction; their interactions in markets determine prices and output.
Features
- Private property – individuals and firms own and control resources and are free to buy and sell them.
- Freedom of choice – consumers decide what to buy; firms decide what to produce.
- Self‑interest and profit motive – economic agents act in their own best interests; firms aim to maximise profits.
- Competition – many buyers and sellers compete, helping to allocate resources efficiently and keep prices down.
- Limited government role – the government provides law and order and certain public goods but generally does not plan production.
Advantages and disadvantages
| Advantages | Disadvantages |
|---|---|
| Efficient allocation of resources through the price mechanism; incentives encourage innovation and productivity; wide variety of goods and services | Inequality of income and wealth; provision of public goods (e.g. street lighting) and merit goods (e.g. education) may be inadequate; market failures such as pollution and monopoly |
| Consumer sovereignty (buyers determine what is produced) | Under‑provision of goods with positive externalities; over‑consumption of goods with negative externalities (e.g. cigarettes) |
| Flexibility to respond to changes in consumer preferences | Resource misallocation in presence of externalities or imperfect information; cyclical instability (boom and bust cycles) |
Pure market economies rarely exist in reality. Most countries operate mixed economies where the government intervenes to correct market failures and provide public services (see Chapters 14 and 15).
