Posted by : Ahsan Khan Thursday, 7 February 2013


A market economy is where economic decisions are made by the free market. That means production of goods and services are regulated by the laws of supply and demand. Producers sell their goods and services at the highest possible price that consumers are willing and able to pay. Workers also bid their services at the highest possible wages that their skills allow.
It is generally thought that any market economy got its start as a traditional or command economy. However, most societies in the modern world have elements of all three, and are therefore mixed economies.

Characteristics of a Market Economy

A market economy is defined by six characteristics:
1. Private Property -- Most goods and services are privately-owned. This allows the owners to make legally binding contracts to buy, sell, lease or rent their property. In other words, their property gives them the right to profit from ownership. However, there are exclusions to what is considered private property. For example, since 1865 the U.S. does not allow you to buy and sell other people, or even yourself. This includes your own body or body parts.
2. Freedom of Choice -- Owners, businesses, consumers and workers are free to produce, sell and purchase goods and services in a free market. Their only constraint is the price they are willing to buy or sell for, and the amount of capital they have.
3. Motive of Self-interest -- The market is driven by everyone trying to sell their goods or services to the highest bidder, while at the same time paying the least for the goods and services they need. Although the motive is selfish, it works to the benefit of the economy over the long run. That's because this auction system fairly prices all goods and services, accurately depicting true supply and demand at any given point in time.
4. Competition -- The forces of competitive pressure keeps prices moderate, and ensures that goods and services are provided most efficiently. That's because, as soon as demand increases for a particular item, prices rise thanks to the law of demand. As competitors see there is additional profit to be made, they start production, adding to supply. This lowers prices to a level where only the best competitors remain. This force of competitive pressure also applies to workers, who are competing with each other for the highest-paying jobs, and consumers, who are competing for the best product at the lowest price.
5. System of Markets and Prices -- A market economy is completely dependent on an efficient market in which to sell goods and services. In an efficient market, all buyers and sellers have equal access, and the same information upon which to base their decisions. Prices rise and fall freely depending purely on the laws of supply and demand.
6. Limited Government -- The role of government is simply to ensure that the markets are open and working. For example, it is in charge of national defense so no other country can destroy the markets. It also makes sure that everyone does have equal access to the markets. For example, government exerts penalties on monopolies, which unfairly restrict competition. The government watches to make sure no one is unfairly manipulating those markets, and that all information is distributed equally.
Whether the society is developed or underdeveloped, a market economy has several important advantages and several major disadvantages: Among the advantages, we find the following:
  1. Competition between different firms leads to increased efficiency, as firms do whatever is necessary—including laying off workers—to lower their costs;
  2. Most people work harder (the threat of losing one's job is a great motivator);
  3. There is more innovation as firms look for new products to sell and cheaper ways to do their work;
  4. Foreign investment is attracted as word gets out about the new opportunities for earning profit;
  5. The size, power, and cost of the state bureaucracy is correspondingly reduced as various activities that are usually associated with the public sector are taken over by private enterprises;
  6. The forces of production, or at least those involved in making those things people with money at home or abroad want to buy, undergo rapid development;
  7. Many people quickly acquire the technical and social skills and knowledge needed to function in this new economy;
  8. A great variety of consumer goods become available for those who have the money to buy them; and
  9. Large parts of the society take on a bright, merry and colorful air as everyone busies himself trying to sell something to someone else.
These are the main advantages of the market economy, and in his article Professor Kang gives a good account of them. But, as I said, there are also major disadvantages, and these Kang neglects. Among the disadvantages, we find the following:
  1. Distorted investment priorities, as wealth gets directed into what will earn the largest profit and not into what most people really need (so public health, public education, and even dikes for periodically swollen rivers receive little attention);
  2. Worsening exploitation of workers, since the harder, faster, and longer people work—just as the less they get paid—the more profit is earned by their employer (with this incentive and driven by the competition, employers are forever finding new ways to intensify exploitation);
  3. Overproduction of goods, since workers as a class are never paid enough to buy back, in their role as consumers, the ever growing amount of goods that they produce (in the era of automation, computerization and robotization, the gap between what workers produce—and can produce—and what their low wage allows them to consume has increased enormously);
  4. Unused industrial capacity (the mountain of unsold goods has resulted in a large percentage of machinery of all kinds lying idle, while many pressing needs—but needs that the people who have them can't pay for—go unmet);
  5. Growing unemployment (machines and raw materials are available, but using them to satisfy the needs of the people who don't have the money to pay for what could be made would not make profits for those who own the machines and raw materials—and in a market economy profits are what matters);
  6. Growing social and economic inequality (the rich get richer and everyone else gets poorer, many absolutely and the rest in relation to the rapidly growing wealth of the rich);
  7. With such a gap between the rich and the poor, egalitarian social relations become impossible (people with a lot of money begin to think of themselves as a better kind of human being and to view the poor with contempt, while the poor feel a mixture of hatred, envy and queasy respect for the rich);
  8. Those with the most money also begin to exercise a disproportional political influence, which they use to help themselves make still more money;
  9. Increase in corruption in all sectors of society, which further increases the power of those with a lot of money and puts those without the money to bribe officials at a severe disadvantage;
  10. Increase in all kinds of economic crimes, with people trying to acquire money illegally when legal means are not available (and sometimes even when they are);
  11. Reduced social benefits and welfare (since such benefits are financed at least in part by taxes, extended benefits generally means reduced profits for the rich; furthermore, any social safety net makes workers less fearful of losing their jobs and consequently less willing to do anything to keep them);
  12. Worsening ecological degradation (since any effort to improve the quality of the air and of the water costs the owners of industry money and reduces profits, our natural home becomes increasingly unlivable);
  13. With all this, people of all classes begin to misunderstand the new social relations and powers that arise through the operations of a market economy as natural phenomena with a life and will of their own (money, for example, gets taken as an almost supernatural power that stands above people and orders their lives, rather than a material vehicle into which people through their alienated relations with their productive activity and its products have poured their own power and potential; and the market itself, which is just one possible way in which social wealth can be distributed, is taken as the way nature itself intended human beings to relate to each other, as more in keeping with basic human nature than any other possibility. As part of this, people no longer believe in a future that could be qualitatively different or in their ability, either individually or collectively, to help bring it about. In short, what Marx called "ideological thinking" becomes general);
  14. The same market experiences develop a set of anti-social attitudes and emotions (people become egotistical, concerned only with themselves. "Me first", "anything for money", "winning in competition no matter what the human costs" become what drives them in all areas of life. They also become very anxious and economically insecure, afraid of losing their job, their home, their sale, etc.; and they worry about money all the time. In this situation, feelings as well as ideas of cooperation and mutual concern are seriously weakened, where they don't disappear altogether, for in a market economy it is against one's personal interest to cooperate with others);
  15. With people's thoughts and emotions effected in these ways by their life in a market economy, it becomes very difficult for the government, any government, to give them a true picture of the country's problems (it is more conducive to stability to feed people illusions of unending economic growth and fairy tales of how they too can get rich. Exaggerating the positive achievements of society and seldom if ever mentioning its negative features is also the best means of attracting foreign investment. With so much of the economy depending on "favorable market psychology", the government simply cannot afford to be completely honest either with its own people or the rest of the world on what is really happening in the country);
  16. Finally, the market economy leads to periodic economic crises, where all these disadvantages develop to a point that most of the advantages I mentioned earlier simply dry up —the economy stops growing, fewer things are made, development of the forces of production slows down, investment drops off, etc. (a close look at the trends apparent in the disadvantages of the market should make clear why such crises are inevitable in a market economy). Until an economic crisis occurs, it is possible to take the position that the advantages of a market economy outweigh its disadvantages, or the opposite position, and to develop a political strategy that accords with one's view, whatever it is. But if a crisis does away with most of the important advantages associated with the market, this is no longer possible. It simply makes no sense to continue arguing that we must give priority to the advantages of the market when they are in the process of disappearing.

Market Economy Examples

The U.S. is most commonly thought of the world's premier market economy. One reason for its success is the U.S. Constitution, which had many provisions that facilitated and protected the market economy's six characteristics. Here's the most important:
  • Article I, Section 8 protects innovation as a property by establishing a copyright clause.
  • Article I, Sections 9 and 10 protects free enterprise and freedom of choice by prohibiting states from taxing each others' goods and services.
  • Amendment IV protects private property and limits government powers by prohibiting people against unreasonable searches and seizures.
  • Amendment V protects the ownership of private property, and Amendment XIV prohibits the state from taking away property without due process of law.
  • Amendments IX and X also limit the government's power by reserving all rights not specifically outlined in Constitution automatically to the people.
The Constitution added in its Preamble a goal to "promote the general welfare." This goal meant the government could take a larger role than that purely prescribed by a market economy. This led to many social safety programs, such as Social Security, food stamps and Medicare.

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