What is a Market Economy?

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Definition:

A market economy is an economy that's mostly regulated by market forces, like the competition between companies and the laws of supply and demand, without significant interference from the government.

🤔 Understanding a market economy

A market economy regulates itself mostly without government interference through the competition of privately owned businesses and the laws of supply and demand. Consumer preference and freedom of choice drive market forces. When prices are high, consumers buy less. When prices are low, consumers buy more. Producers create more products when demand is high and produce less when demand falls. Competition among companies inspires both efficiency and innovation. The self-interest of private companies to earn profit benefits consumers by providing them with the products and services they want. A market economy is not governed in a way geared toward reducing income inequality, nor does it prioritize making sure that poor people can afford the goods and services they need.

Example

The United States, generally speaking, is considered to have a market economy because the government has minimal involvement in directing what goods are produced and what prices are set by businesses. By way of contrast, North Korea has a command economy, where the central government has an extreme level of control over all business activities.

Takeaway

A market economy is like a minimally tended garden…

Flowers and weeds will grow or perish according to the laws of nature — It may be beautiful, but it could also get unruly.

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What is a market economy?

A market economy is an economic system where individuals decide what products to make, how to make them, and who to sell them to — mostly without government intervention.

All social groups must decide three things to create an economic system:

  1. What to produce.
  2. How to produce it.
  3. Who gets the product.

In a free-market economy, the buyers decide what to produce by sending signals to the sellers through their buying patterns. The sellers have private ownership and choose what to create, and buyers (via money) decide who gets the products or services. A pure market economy regulates itself through competition (companies competing for customers) and the laws of supply and demand with no outside control.

The idea of the free or pure market economy is that businesses meet society’s needs by seeking their own self-interest. For sellers to do well, they have to create products that benefit buyers. When buyers are satisfied, companies thrive. Economists call this the “invisible hand” of the market.

What is a mixed economy?

Most modern economies are some type of market economy, but none are a pure market economy. You always have some types of limited government involvement affecting the market in some way, which can change over time as economies change over time.

For example, market economies like Denmark, Canada, Japan, and England have developed elements of a planned economy (an economy controlled by the government) because their governments control and/or provide some type of universal healthcare.

In some economies, like North Korea, the government completely controls how people produce and exchange goods and services. North Korea is called a command economy because the government commands all of the factors of production (things you need to produce anything) — the land, labor, and capital. There is no free will or choice. Command economies are also called planned economies.

Some command economies, like China, have adopted elements of a market economy, which makes China a mixed economy. While the government of China controls many industries, reforms over the last few decades have allowed private companies to compete with government-owned enterprises, which has increased China’s economic efficiency and entrepreneurship.

In reality, there are no pure free-market economies. Every economy in the world lies somewhere on the spectrum between a command economy and a free-market economy.

How does the Constitution affect the market economy in the United States?

Like most economies in developed countries, America is a mixed economy. It’s a market economy with some elements of a planned economy (government involvement) that have developed over time. The Constitution of the United States and its succeeding Amendments were drafted to both protect some aspects of the market economy and extend limited government control to other aspects of the US market economy.

Some ways the Constitution both protects the market economy and allows government involvement are:

  • The government can set market standards: The government sets weights and measures. If you’re buying rice by the ounce, you need to agree on what an ounce is. (Article I, Section 8)
  • The government can create money: The Constitution gives exclusive power to the federal government to create a national currency with established value. (Article I, Section 8)
  • The government can raise money: The government can impose taxes, borrow money, and loan money. (Article I, Section 8)
  • Granted copyrights: The government grants innovators and inventors protection of ownership over their creations by establishing a copyright clause. (Article I, Section 8)
  • Protected private property: Property has protections against unreasonable government searches and seizures conducted without probable cause. (Fourth Amendment). - Protects ownership of property: The government cannot deprive individuals of property without due process of law. (Fifth Amendment and 14th Amendment)
  • Protects free trade among states: States can’t tax each other’s goods and services because it would limit economic liberties and free choice. (Article 1, Section 9 and 10)

How do laws and regulations affect the economy in the United States?

A pure market economy approach assumes that everyone will play fair. In the real world, companies, in their quest to be competitive, can exploit labor, stifle competition by dominating industries, pollute the environment, and produce dangerous or faulty products.

By the turn of the 20th century, problems arose that prompted more government influence in the economy. For example, Standard Oil became a huge monopoly operating under a trust that made it impossible for other oil companies to compete against it. The government broke the company up with the first of its series of antitrust laws.

Over the years, as more issues surfaced, more laws and regulations were put in place to try to both regulate the economy and the quality and safety of the products we buy. Some of these regulations can be seen in the following ways.

  • Social safety nets: The government steps in with welfare programs like food stamps and Medicaid to balance income inequality.
  • Labor force: Education is required to a certain age by law so that adults will be productive workers in the economy.
  • Economic diversity: Corporations can squash or absorb competition by becoming too big and controlling an industry. The government created antitrust laws that can allow it to break up big monopolies into smaller companies.
  • Business development: Tariffs are taxes imposed on imported products made in other countries. The government can lower tariffs to create competition and lower prices, or increase tariffs to allow American businesses to compete without foreign competition. It can also provide subsidies (give money) to businesses in industries it thinks are important — like renewable energy, technology, or farming.
  • Employee protection: The government set labor standards like overtime rules, regulates the safety of working environments, and established a federal minimum wage.
  • Consumer protection: The Federal Drug Administration (FDA) tries to make sure medicines don’t kill us and the Dept of Agriculture inspects meat. The National Traffic and Motor Vehicle Safety Act made cars safer, and the Consumer Products Safety Commission helps save us from exploding microwave ovens.
  • Environment protection: The Environmental Protection Agency (EPA) tries to protect our environment, which directly affects the means of production. While it may be more efficient for farmers to use toxic pesticides, they annihilate important ecosystems and poison our food.
  • Monetary policy — The Federal Reserve (the Fed) is a key player in the US economy. Its goals are to maintain economic stability and employment levels. It serves several functions such as:
  1. Oversees the money supply and adjusts interest rates
  2. Maintains a payments system between financial institutions
  3. Regulates banks

There’s always a trade-off or opportunity cost when you compare regulation to a pure or free-market economy. Decreasing air pollution from leaded gas-run cars increases production costs, which means more expensive cars. Increased interest rates to fend off inflation make credit products cost more.

Labor standards make it harder for small businesses to hire the staff they need to compete in the marketplace. Saving the planet makes producing some goods more expensive. Truly saving the planet may mean eliminating many products. The list goes on.

Government involvement continues to ebb and flow in the form of regulation and deregulation constantly. The perfect amount of government involvement for you depends on your values and ideologies. Do you want universal healthcare or lower taxes? These issues are decided by voters and elected officials.

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