Market Economy is an economic system where the fundamental decisions of what, how, and whom to produce are resolving through the market.
In a market economy, the interaction of supply and demand determines the equilibrium quantity and price of the goods and services traded. Likewise, the market is responsible for income distribution through the possession of productive factors (capital, labor, etc.)
The State, for its part, would have the role of providing a legal framework that allows free competition and initiative of companies. It includes the protection of property rights, the mediation of conflicts (Courts), and subsidiary action in those cases in which competition is not feasible or is limited.
These economic agents produce and consume looking for a financial benefit or a certain level of utility, respectively, in a market with many other individuals or companies that lend themselves to interaction with the same objective. It originates from the scarcity of resources, making it necessary to develop different activities and consumption decisions.
Characteristics of a Market Economy
Below we describe the essential characteristics of a market economy:
- It is Decentralized
The fundamental problems of every economy are solve through the free interaction of individuals. It is then a decentralized election system.
- It Works through Signals
Actions are coordinates through signals without the individuals fully knowing the processes that generate these signals. Although, In a market economy, the key signs are prices, which indicate the relative scarcity of resources.
- Distribute Income
The income of the factors produced is distributing according to who owns them at a given time. Thus, workers will pay according to what they can contribute to the production process. In contrast, the owners of machinery and buildings will receive income according to these goods’ contribution to production.
- Creative Destruction
Competition for consumer preferences generates innovation. Although, Companies that cannot adapt to changes in the environment and consumer preferences will have to exit the market and be replaced by others.
Positive Aspects of the Market Economy
The main advantages of the market economy are as follows:
- When the market is competitive, the efficient use of resources will lead to economic growthand increased competition.
- It promotes innovation and efficiency by forcing companies to compete and improve continuously.
- It prevents governments and institutions from distorting economic activities responding to different individual or power group interests. Therefore, it does not require central planning, where the authorities must decide without having complete information on costs, preferences, and other factors that affect the market equilibrium. The State should have a role as protector of property rights and the competitive environment.
Negative aspects of the Market Economy
The main disadvantages of the market economy are as follows:
- There may be problems in terms of efficiency and, therefore, the appearance of externalities or market failures: situations of social injustice, contamination, or exclusion that lead the public sector to intervene.
- Creation of monopoly or oligopoly situations, reducing the level of competition and increasing price levels.
- And also, It can lead to a morally unacceptable distribution of resources.
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