Market economy

Market economy

A market economy is an economy in which the prices of goods and services are determined in a free price system.[1] This is often contrasted with a state-directed or planned economy. Market economies can range from hypothetically pure laissez-faire variants to an assortment of real-world mixed economies, where the price system is under some state control or at least heavily regulated. In mixed economies, state-directed economic planning is not as extensive as in a planned economy.

In the real world, market economies do not exist in pure form, as societies and governments regulate them to varying degrees rather than allow full self-regulation by market forces.[2][3] The term free-market economy is sometimes used synonymously with market economy,[4] but, as Ludwig Erhard once pointed out, this does not preclude an economy from having social attributes opposed to a laissez-faire system.

The term used by itself can be somewhat misleading. For example, the United States constitutes a mixed economy (substantial market regulation, agricultural subsidies, extensive government-funded research and development, Medicare/Medicaid), yet at the same time it is foundationally rooted in a market economy. Different perspectives exist as to how strong a role the government should have in both guiding the market economy and addressing the inequalities the market produces. This is evidenced by the current lack of consensus on issues such as central banking and welfare.

It is also possible to envision an economic system based on independent producers, cooperative, democratic worker ownership and market allocation of final goods and services; the self-managed market economy is one of several proposed forms of market socialism.[5]



Although no country has ever had within its border an economy in which all markets were absolutely free, the term typically is not used in an absolute sense. Many states which are said to have a market economy have a high level of market freedom, even if it is less than some parts of the population would prefer. Thus, almost all economies in the world today are mixed economies with varying degrees of free market and planned economy traits. For example, in the United States there are more market economy traits than in the Western European countries (an exception being the UK, which is considered, even by Greenspan, to be a freer market than the US).[6]


Capitalism generally refers to an economic system in which the means of production are all or mostly privately owned and operated for profit, and in which investments, distribution, income, and pricing of goods and services are determined through the operation of a market economy. It is usually considered to involve the right of individuals and groups of individuals acting as "legal persons" or corporations to trade capital goods, labor, land and money. Capitalism rarely results in change for the public good, as the market is unable to correct itself in almost all cases.

Capitalism has been dominant in the Western world since the end of feudalism, but most feel that the term "mixed economies" more precisely describes most contemporary economies, due to their containing both private-owned and state-owned enterprises, combining elements of capitalism and socialism, or mixing the characteristics of market economies and planned economies. In capitalism, there is no central planning authority but the prices are decided by the demand-supply scale. For example, higher demand for certain goods and services lead to higher prices and lower demand for certain goods lead to lower prices.


Laissez-faire is synonymous with what was referred to as strict capitalist free market economy during the early and mid-19th century as an ideal to achieve. It is generally understood that the necessary components for the functioning of an idealized free market include the complete absence of government regulation, subsidies, artificial price pressures and government-granted monopolies (usually classified as coercive monopoly by free market advocates) and no taxes or tariffs other than what is necessary for the government to provide protection from coercion and theft and maintaining peace, and property rights.

Milton Friedman and Friedrich Hayek stated that economic freedom is a necessary condition for the creation and sustainability of civil and political freedoms. They believed that this economic freedom can only be achieved in a market-oriented economy, specifically a free market economy. They do believe, however, that sufficient economic freedom can be achieved in economies with functioning markets through price mechanisms and private property rights. They believe that the more economic freedom that is available, the more civil and political freedoms a society will enjoy.

Friedman states:

  • "Economic freedom is simply a requisite for political freedom. By enabling people to cooperate with one another without coercion or central direction it reduces the area over which political power is exercised" Friedman, Milton and Rose Friedman, Free to Choose: A Personal Statement, Harcourt Brace Jovanovich, 1980, p. 2-3
  • "Capitalism is a necessary condition for political freedom" Capitalism and freedom

Studies by the Canadian libertarian think tank Fraser Institute and the American conservative think tank Heritage Foundation state that there is a relationship between economic freedom and political and civil freedoms to the extent claimed by Friedrich von Hayek. They agree with Hayek that those countries which restrict economic freedom ultimately restrict civil and political freedoms.[7][8]

Generally market economies are bottom-up in decision-making as consumers convey information to producers through prices paid in market transactions. All states today have some form of control over the market that removes the free and unrestricted direction of resources from consumers and prices such as tariffs and corporate subsidies. Milton Friedman and many other microeconomists believe that these forms of intervention provide incentives for resources to be misused and wasted, producing products society may not value as much as a product that is valued as a result of these restrictions.

Social market economy

This model was implemented by Alfred Müller-Armack and Ludwig Erhard after World War II in West Germany. The social market economic model is based upon the idea to realise the benefits of a free market economy, especially on economic performance and high supply of goods, while avoiding disadvantages such as market failure, destructive competition, concentration of economic power and anti-social effects of market processes. The aim of the social market economy is to realize greatest prosperity combined with best possible social security. As a difference to the free market economy the state is not passive, but actively takes regulative measures.[9] The social policy objectives include employment, housing and education policies, as well as a socio-politically motivated balancing of the distribution of income growth. Characteristics of social market economies are a strong competition policy and a contractionary monetary policy. The theoretical fundament is build on ordoliberalism, Catholic social teaching and Democratic Socialism.[10]

Market socialism

Market socialism refers to various economic systems in which the state owns the economic institutions and major industries but operates them according to the rules of supply and demand. In a traditional market socialist economy, prices would be determined by a government planning ministry, and enterprises would either be state-owned or cooperatively-owned and managed by their employees. The distinguishing feature between non-market socialism and market socialism is the existence of a market for the means of production, and the criteria of profitability for public enterprises; which can either be used to reinvest in production or finance government and social services directly.

Libertarian socialists and left-anarchists often promote a form of market socialism in which enterprises are owned and managed cooperatively by the workers so that the profits directly remunerate the employee-owners. These cooperative enterprises would compete with each other in the same way private companies compete in a capitalist market. An example would be Mutualism (economic theory).

Socialist market economy

The People's Republic of China currently has a form of market socialism referred to as the socialist market economy, in which most of the industry is state-owned through a shareholder system, but prices are set by a largely free-price system. Within this model, the state-owned enterprises are free from excessive micromanagement and function more autonomously in a decentralized fashion than in planned economies. A similar socialist-oriented market system has been implemented in Vietnam following the Doi Moi reforms.


Robin Hahnel and Michael Albert

"(...) claim that markets inherently produce class division" {divisions between conceptual and manual laborers, and ultimately managers and workers, and a de facto labor market for conceptual workers}. Albert says that even if everyone started out with a balanced job complex {doing a mix of roles of varying creativity, responsibility and empowerment} in a market economy, class divisions would arise. Without taking the argument that far, it is evident that in a market system with uneven distribution of empowering work, such as Economic Democracy {the model of market socialism David Schweickart has developed and refers to as "economic democracy"}, some workers will be more able than others to capture the benefits of economic gain. For example if one worker designs cars and another builds them, the designer will use his cognitive skills more frequently than the builder. In the long term, the designer will become more adept at conceptual work than the builder, giving the designer greater bargaining power in a firm over the distribution of income. A conceptual worker who is not satisfied with his income can threaten to work for a company that will pay him more (...)".[11] Therefore according to this critique class divisions would arise inevitably.

Another practical objection is the claim that markets do not take into account externalities (effects of transactions that affect third parties), such as the negative effects of pollution or the positive effects of education. What exactly constitutes an externality may be up for debate, including the extent to which it changes based upon the political climate. Some proponents of market economies believe that governments should not diminish market freedom because they disagree on what is a market externality and what are government-created externalities, and disagree over what the appropriate level of intervention is necessary to solve market-created externalities. Others believe that government should intervene to prevent market failure while preserving the general character of a market economy. In the model of a social market economy the state intervenes where the market does not meet political demands. John Rawls was a prominent proponent of this idea.

See also


  1. ^ Altvater, E. (1993). The Future of the Market: An Essay on the Regulation of Money and Nature After the Collapse of "Actually Existing Socialism. Verso. pp. 57. 
  2. ^ Altvater, E. (1993). The Future of the Market: An Essay on the Regulation of Money and Nature After the Collapse of "Actually Existing Socialism. Verso. pp. 237–238. 
  3. ^ Tucker, Irvin B. p 491. Macroeconomics for Today. West Publishing. p. 491
  4. ^ "market economy", Merriam-Webster Unabridged Dictionary
  5. ^ "What is capitalism?". World Socialist Movement. 
  6. ^ McKinney, Michael L. Environmental Science: Systems and Solutions. Jones and Bartlett Publishers. 2003. p. 481
  7. ^ Heritage Foundation study
  8. ^ Economic Freedom of the World Report by the Frasier Institute
  9. ^ keyword "social market economy" = “Soziale Marktwirtschaft” Duden Wirtschaft von A bis Z. Grundlagenwissen für Schule und Studium, Beruf und Alltag. 2. Aufl. Mannheim: Bibliographisches Institut & F.A. Brockhaus 2004. Lizenzausgabe Bonn: Bundeszentrale für politische Bildung 2004.
  10. ^ Gabler Wirtschaftslexikon: Eintrag: keyword "social market economy" = Soziale Marktwirtschaft
  11. ^ Weiss, Adam (2005-05-04). "A Comparison of Economic Democracy and Participatory Economics". ZMag. Retrieved 2008-06-26. 

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