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A market economy is an economic system in which the decisions regarding investment, production and distribution to the consumers are guided by the price signals created by the forces of supply and demand. The major characteristic of a market economy is the existence of factor markets that play a dominant role in the allocation of capital and the factors of production.[1][2]
Market economies range from minimally regulated free-market and laissez-faire systems where state activity is restricted to providing public goods and services and safeguarding private ownership,[3] to interventionist forms where the government plays an active role in correcting market failures and promoting social welfare, as seen in some mixed economies. State intervention can happen at the production, distribution, trade and consumption areas in the economy. The distribution of basic need services and goods like health care may be entirely regulated by an egalitarian public health care policy (while having the production provided by private enterprise), effectively eliminating the forces of supply and demand.
State-directed or dirigist economies are those where the state plays a directive role in guiding the overall development of the market through industrial policies or indicative planning—which guides yet does not substitute the market for economic planning—a form sometimes referred to as a mixed economy.[4][5]
Market economies are contrasted with planned economies where investment and production decisions are embodied in an integrated economy-wide economic plan. In a centrally planned economy, economic planning is the principal allocation mechanism between firms rather than markets, with the economy's means of production being owned and operated by a single organizational body.
Characteristics
Property rights
For market economies to function efficiently, governments must establish clearly defined and enforceable property rights for assets and capital goods. However, property rights does not specifically mean private property rights and market economies do not logically presuppose the existence of private ownership of the means of production. Market economies can and often do include various types of cooperatives or autonomous state-owned enterprises that acquire capital goods and raw materials in capital markets. These enterprises utilize a market-determined free price system to allocate capital goods and labor.[6] In addition, there are many variations of market socialism where the majority of capital assets are socially owned with markets allocating resources between socially owned firms. These models range from systems based on employee-owned enterprises based on self-management to a combination of public ownership of the means of production with factor markets.[7]
Supply and demand
Market economies rely upon a price system to signal market actors to adjust production and investment. Price formation relies on the interaction of supply and demand to reach or approximate an equilibrium where unit price for a particular good or service is at a point where the quantity demanded equals the quantity supplied.
Governments can intervene by establishing price ceilings or price floors in specific markets (such as minimum wage laws in the labor market), or use fiscal policy to discourage certain consumer behavior or to address market externalities generated by certain transactions (Pigovian taxes). Different perspectives exist on the role of government in both regulating and guiding market economies and in addressing social inequalities produced by markets. Fundamentally, a market economy requires that a price system affected by supply and demand exists as the primary mechanism for allocating resources irrespective of the level of regulation.