What is Market Economy? We have heard many times that the economy is a market economy. This is a common term, which is used broadly by most of us. However, one should not get confused with this. What is Market Economy is quite different from what is commonly understood.
A market economy is a system where the decisions regarding production, investment and distribution are affected by the fluctuations in the market prices. The concept of Market economy is related to the concept of the business cycle. It is a very general approach towards economic activities. The concept of the business cycle defines the process of production and consumption, which moves from one stage to another in the economy.
Now, a market economy mainly focuses on the process of production and demand, and the prices are determined by demand and supply factors. In the market, prices depend on the competition. If there is excess production of a good at a high rate, then the price of the good goes up. Similarly, if there is a shortage of a good, or if the demand for a good exceeds the supply, then the prices go down. Hence, it can be said that production and consumption affect the prices of goods and services.
It has also been defined as a state of prosperity or luxury, based on investment and savings. The concept of Market economy has various applications in the field of economic theory. The main functions of it include the allocation of resources effectively, to gain maximum benefit from economic activity. The prices are controlled to ensure that the allocation of resources is in the interest of all users. It is also widely applied in the theory of macro economics to explain how economies grow and develop.
The fact that the market economy differs from the traditional economy is not at all surprising. Traditional economies are based on demand and supply channels, whereas the market economy operates on demand and supply channels. The difference is quite obvious in the level of taxation and other government regulation. The former focuses on raising the share of income and profits, while the latter aims at reducing the non-reemployment rate. In addition to that, the distribution of income and wealth in the market economy differs in comparison to the traditional economy.
The market economy operates through various channels, and there is substantial scope for changes in the level of prices. It is based on the principle of competition and the fact that prices are subject to elasticities. The goods and services are normally produced in large quantities, so there is a constant demand for them. However, there is a tendency towards overproduction of certain goods and services, which lead to underproduction and surplus reduction. As the demand for the goods and services increases, there is a pressure for the size of the input resources, which leads to a further increase in prices.
One of the major distinguishing characteristics of the market economy is the absence of centralised force, such as the government or the ownership of a specific physical entity. There are no requisites for the operation of the economy. Prices depend only on demand and supply forces. Unlike the traditional economy, the market does not have any unallocated physical assets like capital or plant that are earmarked for particular purposes, and can be taken for granted.
What is Market economy is thus defined as a system where goods and services are produced in accordance with individual consumer demand, both long and short term. Unlike the traditional economy, it does not require large scale production for particular purposes, but uses small scale production to meet general and short term demand. The end result of all this production is to make large quantities of the good or service available for individual consumption.