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What Are the Characteristics of a Market Economy?

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  • Last Modified Date: 18 October 2014
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A market economy is one in which most financial decisions are made by both the citizens of a country and by the businesses which cater to those citizens. One of the chief characteristics of a market economy is the fact that the amount of production of goods and the prices for those goods are determined by the laws of supply and demand. In general, market economies are generally left to develop without much intervention from any type of governmental body. Other characteristics of a market economy include its flexibility and the fact that there is no centralized force behind economic momentum.

There are two extremes in terms of the economic identity of specific countries. A planned economy is one in which the majority of the decisions pertaining to the economy are made by the government. By contrast, a market economy is one in which the market itself, driven by the actions of consumers and producers, is the ultimate determining factor for aspects of the economy like pricing and production. As a result, the characteristics of a market economy are such that they are flexible and react to the stimuli within the market rather than to any government interference.

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The law of supply and demand is one of the defining characteristics of a market economy. This means that the amount of a particular good will have an effect on how much the consumers want that product. In general, these two forces work in inverse proportion to each other, meaning that demand rises when supply falls, and demand falls when supply rises.

Knowing this, the businesses in charge of production of the various goods and services on sale in a market economy will react to consumers' interest in these goods and services. As demand for a specific product rises, businesses will raise the product's price in reaction to this. After a while, the price will become too high for consumers to pay, and they will cease buying the product at that level. That will lessen demand and raise supply, and the price will drop. Equilibrium is eventually reached in this manner.

While these characteristics of a market economy tend to dominate the economies of countries around the world, they are often tempered by some level of governmental intervention. For that reason, it is rare that a pure market economy exists in the world. Most economies are mixed between the characteristics of a market economy and those of a planned economy.

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literally45
Post 3

Another characteristic of the market economy is that it keeps inflation in check. In planned economies, if the government is running on a deficit, but needs to keep people happy, it will raise income and then raise prices. So people think that they are making more money but the market is taking it back with the price of goods. This is not possible in a market economy, so the prices are real and inflation is mostly kept under control.

donasmrs
Post 2

@turquoise-- A market economy encourages competition. If a product is profitable and if there is demand for it, more companies will produce it to get a piece of the pie. The good part about this is that consumers end up with more options. The competition also results in better quality products at lower prices.

Because there is a lot of competition in a market economy though, there has to be some regulation by the government to make sure that the competition is fair. If the market is left alone, there will be a monopoly in each industry where one or two manufacturers will produce all the goods and make all the profit. In order for small manufacturers to enter and compete in the economy, the government has to set rules for the game.

This is why open market economies are called mixed economies, because of this limited government regulation.

turquoise
Post 1

What is competition like in a market economy? Is a market economy favorable to competition?

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