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Introduction and Characteristics (Features):

A market economic system or market economy is also referred to as a capitalist economy or private enterprise economic system.

The reasons for the term market economy are evident. A market is where buying, selling and exchange take place; so a market economy allocates resources and distribution of goods and services (buying, selling and exchange) throughout the economy with minimal control and regulation.

The five key elements or characteristics or features that distinguish a market economy from other types of economic systems are:

(i) The means of production are in private ownership.

(ii) Economic decision-making is decentralized.

(iii) Economic motivation is self-interest (profit for companies, utility for consumers).

(iv) The allocative mechanism is price.

(v) Efficiency is valued over equity.

Remember, though, that we are describing a pure market economy; in the real world, few economies approach this extreme.

These five features of the market economy are further explained below:

(i) Private Ownership:

In a market economy the individual is free to own land and capital resources, and buy and sell the factors of production or economic resources; land, labor, capital and enterprise. Individuals are considered to own their own labor, which they can sell for a wage if they desire. The private ownership of economic resources and the factors of production can be passed on to future generations, sold to overseas buyers or used (or not used) for any purpose the owner decides. There is no directive on resource use other than the individual’s decision.

The reasons behind this level of individualism are that individuals are considered the best judge of their own welfare. Individuals are thought to be able to make the best decisions on how to use or dispose of their resources, including decisions such as whether to sell their labor (be employed), for how much (a wage) and for how long (the opportunity cost and trade-off between work and leisure).

(ii) Decentralized Decisions:

In the extreme form of market economy, economic decision-making is left to the individual. There is no government intervention in the market, and all economic decisions are decentralized. The role of the state is restricted to providing a legal system and enforcing the law, national security, and administering a framework by which trade and commerce can take place within the market.

For example, such a state would not set minimum wage levels. The employers, the buyers of labor, would have to offer a sufficient wage to the sellers of labor to induce them to work.

If the wage that was offered was too low, people would value their leisure overwork; employers would have to improve their offer to get people to work. (Overtime, for example, is paid at a higher hourly rate as reward and incentive from employers to employees).

(iii) Self-interest:

The third distinguishing element of the market economy is that the individual is economically driven and motivated through the pursuit of self-interest. Maximizing individual economic welfare is at the expense of any attempts to directly maximize collective welfare. Market economists assert that maximizing individual welfare will produce collective welfare as a consequence.

The economic motivation for producers is profit. They produce and sell goods and services, using the factors of production available to them, for more than it cost to produce. This profit (revenue – cost) is theirs to spend, save or use to produce more profit.

The consumer is motivated by what economists call utility or satisfaction. Goods and services are purchased because they provide the consumer with utility. But consumers’ ability to purchase, the more income you need, which generally means selling more labor, which will mean less time to consume the goods and services you wish to purchase. It is a case of scarcity and opportunity cost once again.

(iv) Allocation by Price:

Price is reliable, efficient and non-interventionist means of allocating limited goods and services among unlimited wants. Perhaps everyone would like to own the latest Audi or BMW, but the car company cannot produce enough cars for everyone. It must allocate its limited and scarce resources (the number of cars produced) among our unlimited demands. Price is the allocative mechanism used. If you have the means to purchase the car and wish to do so, and there is one available, then you purchase the car. The price system is the method of allocating the scarce commodity to a restricted number of consumers. Alternatives are to hold a lottery or form a queue (first come, first served).

(v) Efficiency is Valued:

Finally, because individuals are motivated by self-interest and attempt to maximize their individual welfare, they are more efficient in their economic decision-making. Production decisions are based on efficiency outcomes to produce greater profits. Consumption decisions are also driven by concerns of efficiency and the need to get the best return on expenditure.