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About Market Economy by Ivan Cavric

    Ivan Cavric
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    By Ivan Cavric

    What is a 'Market Economy'

    A market economy is an economic system in which economic decisions and the pricing of goods and services are guided solely by the total interactions of a country's individual citizens and businesses. There is little government involvement or central planning. This is the opposite of a centrally planned economy, in which government decisions drive most feature of a country's economic activity.

    BREAKING DOWN 'Market Economy'

    The theoretical basis for market economies was developed by classical economic such as Adam Smith, David Ricardo and Jean-Baptiste Say in the late 19th and early 20th centuries. These classically liberal free market advocates believed that protectionism and government involvement tended to lead to economic inefficiencies that actually made people worse off.

    Market Theory

    Market economies work on the assumption that forces such as supply and demand are the best determinants of aggregate wellbeing. Strict adherents to the theory rarely engage in government interventions such as price fixing, license quotas and industry subsidies. Theoretical proponents argue that central planners could not possibly gather and analyze enough information to make the optimal economic decision for all participants. Instead, each rational person with perfect information and free will should be able to maximize his well being given the set of options with which he is presented. Moreover, this allows individuals to attach different amounts of value to leisure, wealth, goods or future consumption. The personal economic value of these different aspects is known as utility. Detractors assert that the conditions that allow markets to function properly cannot hold in the real world. They contend that information is not perfect and universal; many people do not behave rationally; and corruption and uninhibited power can allow certain actors to exercise undue influence at the expense of others.

    Modern Market Economies

    Almost every economy in the modern world falls somewhere along a continuum running from pure market to fully planned. Most developed nations are technically mixed economies because they blend free markets with some government interference. However, they are often said to have market economies because they allow market forces to drive the vast majority of activities, typically engaging in government intervention only to the extent it is needed to provide stability.

    Although the market economy is clearly the popular system of choice, there is significant debate regarding the amount of government intervention considered optimal for efficient economic operations. Nations such as Cuba, China and North Korea have been heavily influenced by the Communist theories under Marxism-Leninism, which promote coordinated economic activity and centralized planning to achieve egalitarian and shared outcomes. Such economies have struggled at times due to corruption, inept leadership, limitations to the application of these theories and trade sanctions from capitalist nations.

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    A centrally planned economy is an economic system in which the state or government makes economic decisions rather than the interaction between consumers and businesses. Unlike a market economy in which private citizens and business owners make production decisions, a centrally planned economy controls what is produced and the distribution and use of resources. State-owned enterprises undertake the production of goods and services.

    BREAKING DOWN 'Centrally Planned Economy'

    Most developed nations have mixed economies that combine aspects of central planning with the free market systems promoted by classical and neoclassical economists. Most of these systems skew heavily toward free markets, with government interventions only for certain trade protections and coordination of certain public services.

    Theory of Central Planning

    Centrally planned economies assume that the market does not work in the best interest of the people and that a central authority needs to make decisions to meet social and national objectives. These justifications are often made on the grounds of egalitarianism, environmentalism, anti-corruption or anti-consumerism, which proponents of central planning do not consider that the free market adequately addresses. The state can set prices for goods and determine how much is produced, and it can focus labor and resources on industries and projects without having to wait for investment capital from the private sector.


    A mixed economic system is an economic system that features characteristics of both capitalism and socialism. A mixed economic system protects private property and allows a level of economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims. According to neoclassical theory, mixed economies are less efficient than pure free markets, but proponents of government interventions argue that the base conditions such as equal information and rational market participants cannot be achieved in practical application.

    !--break--Most modern economies feature a synthesis of two or more economic systems, with economies falling at some point along a continuum. The public sector works alongside the private sector, but may compete for the same limited resources. Mixed economic systems do not block the private sector from profit-seeking, but do monitor profit levels and may nationalize companies that are deemed impediments to the public good. The United States is mostly a free market economy, but it incorporates elements such as protection for agriculture and manufacturing by through trade restrictions and subsidies. This makes the United States a mixed economy by definition.

    Difference from Free Markets

    Mixed economic systems are not laissez-faire systems, because the government is involved in planning the use of some resources and can exert control over businesses in the private sector. Governments may seek to redistribute wealth by taxing the private sector, and using funds from taxes to promote social objectives. Trade protection, subsidies, targeted tax credits, fiscal stimulus and public-private partnerships are common examples of government intervention in mixed economies. These usually do not generate massive economic distortions, but instead are instruments to achieve specific goals.

    Countries often interfere in markets to promote target industries by creating agglomerations and reducing barriers to entry in an attempt to achieve comparative advantage. This was common among different East Asian countries in the 20th century, and the region has turned into a global manufacturing center for a variety of industries. Some nations have come to specialize in textiles, while others are known for machinery, and others are hubs for electronic components. These sectors rose to prominence after governments protected young companies as they achieved competitive scale and promoted adjacent services such as shipping.

    Difference from Socialism

    Socialism entails more social ownership of the means of production. Proponents of socialism believe that central planning can achieve greater good for a larger number of people. They do not trust that free market outcomes will achieve the efficiency and optimization posited by classical economists, so socialists advocate measures that can include price fixing, income redistribution and intense trade restriction. Mixed economies rarely go to this extreme, instead identifying only select instances in which intervention could achieve outcomes unlikely to be achieved in free markets.

     

     

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