Introduction: An economy is usually composed of different players. The economy of a given region basically involves the production, distribution, and consumption of products and services within that area. It entails the activities that people engage in to earn a living.
Different types of economies exist. They are namely command, traditional, mixed and market economies. They all vary in how they function, with each having its own advantages and disadvantages.
A market economy has been favored by many governments because it promotes free trade by allowing the forces of demand and supply to determine the prices of products and services. Like the other types of economies, it has its unique features as well as advantages and disadvantages.
Meaning of Market Economy
When we talk about a market economy, what are we really referring to?
* A Market economy can simply be defined as a free market, one in which there are no outside authorities charged with determining the prices of goods and services or fixing them at a certain amount.
* In this type of economy, there is very minimal intervention by the government. This would be counterproductive since some parties would be disadvantaged.
* A market economy allows a free price system in that prices are determined by the interactions of several players within an economy. These interactions are usually between the buyers and sellers.
* It can also be said that a market economy is a type of economy where competition between businesses informs the cost of goods and services. Businesses fix prices of goods and services based on their need to make profits and the desire to outperform the competition.
* This is a type of trading environment where the government makes laws and provides regulations to guide operations but does not interfere with the actual pricing of goods and services. This is left to the market forces.
* There is unrestricted competition among private enterprises so that their prosperity is determined by how best they can capture customers and increase revenue generation. Every entrepreneur has a shot at success.
All these definitions help us to understand the key components of such an economy. It can be seen that it promotes free enterprise and allows business owners to make reasonable profits from their investments. The government merely acts as a supervisor of some sorts so that consumers are not exploited while entrepreneurs earn profits from their trades.
Features of a free market economy
As mentioned earlier, there are four different types of economies, each with its own unique characteristics. What are some of the key features of a market economy that make it different from the rest? Here are some of them:
1. Free market: This is a phrase that comes up quite often when speaking about trade and the economy in general. Most of the times we listen to experts talking about the need to have a free market if the economy of a nation is to thrive. It is a key feature of this type of economy but just what does it mean? When talking about a free market, we are referring to a business environment where the prices of products and services are controlled by the interactions between consumers and private businesses. The government does not act to fix these prices and its role is only limited to ensuring fair play to avoid customer exploitation. The laws of demand and supply determine the cost of goods and services and not some other authority. In a free market, no one person or even organization enjoys the monopoly of setting prices. In simple terms, in such a market, entrepreneurs trade in a business environment where they are allowed to operate freely but within the confines of the law. A free market is what really defines a market economy. It is the dominant feature that separates it from the other types of economies.
2. Free price system: This is another important feature of a market economy. The prices of goods and services are determined by the forces of demand and supply. The resulting price is what guides the production and distribution of goods. Take this for example; vegetables that are seasonal are more expensive when they are out of season than when they are in season. This is because the supply is high when they are in season and the opposite is also true. Forces of demand and supply work in such a way that when supply is high, demand and prices fall and vice versa. This is because the produce is readily available to retailers and obtaining them does not require a lot of resources. Farmers do not spend much in growing crops when the season is favorable as compared to when it is not. A free price system depends on these forces to attach value to a commodity or service.
3. Unrestricted competition among private enterprises: In a market economy, private enterprises compete for the available business space as well as the customers. They can increase brand awareness through advertising, better products and services offering, and improved customer services. This unrestricted competition allows businesses to focus on product differentiation rather than increasing the volume of production because that is what will attract more customers and increase sales. This healthy competition makes it possible for the most hard working business people with the best strategies to thrive. It works to the advantage of consumers by improving the quality of products that they are sold. It is to be noted that unrestricted competition is only allowed when ethical tactics are used to win over consumers. The regulations and policies that are put in place by the government ensure that consumers do not fall victim to false advertising.
4. Minimal government intervention: The government does really interfere with trade in a market economy. It does not get involved unless it has to. A scenario where the government can flex its muscles in a free market include cases of exploitation of consumers by enterprises. It does this by penalizing the businesses that do this and also by introducing legislation to prevent future occurrences.
5. Profit motive: One important aspect of a market economy is that businesses are motivated by profits. A company will craft strategies to attract the highest possible number of customers and generate maximum profits while consumers will want to buy the best quality of products at the lowest of prices. These are the dynamics of a market economy and the success of a business is measured by how much profit it rakes in. Retained profits are usually used as capital for expansion and business growth. Profits act as incentives that motivate firms to continue with business operations because, at the end of the day, there is a reward for all the work that is put in. Without reasonable profits, businesses would close shop since it wouldn't make sense to continue offering products and services.
6. Consumer freedom: In a free market, consumers have the right to choose which business to engage with. They are not restricted to purchasing from a specific firm. The availability of different choices makes it possible for this to happen. Enterprises must, therefore, act to convince customers that they are the best options for them and provide incentives to retain them. It is this consumer sovereignty that pushes businesses to treat customers with decency since they always have the freedom of choice. A customer can decide to walk away from your firm and deal with the competition and that would put a dent in your business.
7. The power of information: Information is also a key feature in a free market. Businesses must use information to determine customer needs and preferences while at the same time consumers must make use of information to know the existence of a business and the best ones to buy from. There are different ways in which information is gathered by the different players in a free market. Customers can use the internet and social networks to gather this information while enterprises can use social intelligence strategies to know customer preferences. A company must keep up with the current trends if it wants to succeed because, in a free market, information is power. The ability for businesses to compete through product differentiation has made it necessary for them to know exactly what the consumer wants. These preferences change so rapidly and with the right use of information and technology, a firm can stay ahead of the competition.
Advantages of a Market Economy
When looking at the features, we've come across some reasons why this type of economy is good. We have seen how it can benefit the entrepreneur, customer, and the government. These are some of its advantages:
1. Competition and business success: It's not bad to compete because competition actually pushes us to break the glass ceiling and see how great we can become. When businesses compete, they strive to become better by generating more revenue and realizing higher profits. An entrepreneur thus has the opportunity to expand his or her operations and achieve financial success. Without competition, they would be so complacent and would remain at the same financial position for a long time. A business owner would be so comfortable with the status quo that he or she wouldn't see the need to push boundaries and grow. After all, what's to bother you when you are assured of your market space? This is the reason why businesses that compete on a national or global level perform better than those that are localized.
2. Growth of the economy: The growth of a country's economy depends on the growth of the private sector. It is not some work of magic that increases the Gross Domestic Product of a nation but the collective work of the private businesses. A free market promotes the growth of this sector and with it the thriving of a country's economy. This carries several benefits such as improved living standards, more employment opportunities, and a higher life expectancy. The easiest way to kill the economy of a country is to interfere with the free growth of enterprises. A market economy, therefore, is beneficial in improving the economic outlook of a geographical region.
3. More investment by the private sector: Investors prefer market conditions where they are allowed to operate freely with minimum government interference. When such conditions exist, they are likely to invest more in the economy. As we've already seen, a thriving private sector is good for the economy of a country. Nations like the U.S have been thriving economically for such a long time because of a strong private sector. The realization of profits is such a good motivation that a lot of people will be willing to put in more work and reap the rewards. When more people opt to invest in the economy, higher growth is realized.
4. Consumer benefits: Consumers actually have a lot to benefit from a free market. Because businesses are competing to have the most number of customers, they focus more on product differentiation which is instrumental in ensuring that quality products are released into the market. Consumers, therefore, get value for money. Lack of monopoly also plays a key role in preventing the exploitation of consumers by businesses that are not experiencing any type of competition. The ease with which firms are able to enter the market and carve out a niche for themselves makes it a fair game. Consumers also have a lot of options to choose from and can still get quality products at the fairest of prices. When it comes to service delivery, a free market pushes firms to offer the best of services because that is what will help them stay in business. Look at what happens in sectors of the economy that are run purely by the government. The delivery of services is so pathetic but people still opt for them because there are no other options. Privatization makes it much better because of increased competition.
5. Businesses operate freely, hence more productivity: A free market is beneficial to entrepreneurs because they can operate freely. Freedom is actually a good thing because it encourages productivity. People are more productive when they do things because they want to and not because they are forced to do so. In a market economy, businesses operate with such freedom that they can thrive and grow way much faster than in a restricted economy. The ability to do business without unnecessary interference from the government triggers a chain reaction of great things such as increased investment and a better performing economy. If you pay attention to what has been going on around the globe, you'll realize that there has been a raging debate on whether governments should place more restrictions on certain businesses in the economy or allow for more freedom. Many experts have been vouching for freedom because that is what promotes growth. Putting price caps and having several restrictions is counterproductive.
6. A smaller variant of Laissez-Faire: Less interference by the government means that businesses have the ability to operate in a fair trading environment. They can sell products at prices determined by market forces and get maximum incentives in the form of profits. A smaller variant of laissez-faire is definitely good for the economy because entrepreneurs will not be afraid to invest.
7. Increased Efficiency: Increased competition will give rise to increased efficiency. Firms will try to keep costs at a minimum and production high. Improved efficiency ensures that resources are not wasted and businesses focus more on streamlining their operations to make this possible.
Disadvantages of a Market Economy
It's difficult to find a system that is completely perfect. Even though we strive to achieve perfection as time goes by and we learn from our failures and mistakes, there are still some areas that will always need adjustments. Here are some of the disadvantages of a market economy:
1. Poor working conditions due to the need for higher profits: Because entrepreneurs want to generate higher profits, they may compromise on the human resources just to increase their margins. This may lead to poor working conditions and pay. A business owner may pay his or her workers below the minimum wage in a bid to increase profits. Some also have their workers working in deplorable conditions because spending money to have an ideal job environment would reduce their profits. It has resulted in the creation of entrepreneurs who will do anything to make more profits.
2. Less social initiatives: This is also brought about by the hunger for more money. Rolling out social initiatives is seen to be eating into company profits and that is not something that an entrepreneur who wants to realize maximum profits would want. Social responsibility should be a moral issue for firms but in a free market economy, that is not something that a lot of companies focus on.
3. Inequality: A market economy has always been referred to as a capitalist market. It favors the accumulation of wealth by individuals who have the opportunity to do so. This creates a state of inequality between the haves and the have-nots. Unequal distribution of wealth results in many social problems because those who are less privileged or poor will try to use unlawful ways to gain access to wealth. People are not born equal and those who had a better foundation will always have a head-start in such an economy. The more privileged in the society may also use their positions to trample on the rights of the poor.
4. Environment and pollution: When people are motivated by profits, they'll pay less attention to how their actions affect the environment. Business owners may engage in production activities that degrade the environment just to increase their profits. Without much government control, firms will not think about the consequences of their actions because after all, it is a free market.
5. No chance for the small person (Survival of the fittest) : In such a market, the fierceness with which enterprises compete makes it very difficult for small businesses to thrive. It is a matter of survival of the fittest and if you don't have the resources to compete then you might as well close shop. An already established business can do everything possible to run you out of business. Only the fittest will survive in the face of ruthless and cut-throat competition. Where then does that leave the small person who is only trying to make it? The answer is 'out of business”.
6. Economic disasters: Giving private businesses free reign can result into economic meltdowns on a global scale. Selfish actions by some of the players in sectors of the economy may lead to a build up of bad consequences. This has been seen time and again especially in the financial sector where profits are made at any possible costs and this often results in economic disasters.
7. Excessive control of private entrepreneurs: Private entrepreneurs may exhibit monopolistic tendencies by restricting output and driving up the cost of goods and services. Even without government input, there are still chances that some investors will create monopolies and exercise excessive control of some sectors of the economy. The rise of cartels is a common phenomenon in a market economy.
Conclusion
We've now looked at both the advantages and disadvantages of a market economy. From these, we have seen that it provides an avenue for wealth creation and allows entrepreneurs to prosper and have a better life. Everyone deserves a fair shot at success and a market economy provides that. Again like mentioned before, every system has its challenges. Nothing created by man is completely perfect since there is always room for improvement. Despite the demerits that come with the free market, the advantages are many and can be built on to have a better and thriving economy.
The government can enact relevant legislation that do not aim at controlling the market but provide policies that support transparency and limit criminal actions by companies. In this way, a system that supports economic growth and protects consumers is realized. It's also good to have an economy that rewards hard work because that is what a market economy does. When all is said and done, having a free market would encourage entrepreneurs to invest more and as a result lead to improved living standards.