Market Economy

A market economy is an economy in which decisions regarding the methods for carrying out investment, production, and distribution are based on supply and demand, which in turn influences the prices of goods and services. Market economies can be immediately recognized by the fact that all of the investment decisions and the allocation of goods are made via negotiations between markets. A market economy differs from a planned economy, which is a system in which decisions relating to investments and production are made as a part of the government’s plans. To explore this concept, consider the following market economy definition.

Definition of Market Economy


  1. An economic system in which there is free competition among private businesses, and prices are determined by supply and demand.


1929    Americanism

Market Economy and Capitalism

A market economy and capitalism have many things in common – in fact, many people tend to use the terms interchangeably. There are some key differences, however. Both systems operate on the principle of supply and demand, however where a free market economy relies solely on that principle – with no interference by the government – capitalism is more focused on the amassing of wealth through ownership of production supplies and facilities.

In a free market economy, the exchange of goods, services, and wealth based on the agreement of each party in what they are willing to pay out and receive. A capitalist system relies on manipulating the factors – even to the point of an owner holding a monopoly on the market of a specific good or service – to generate greater riches.

Free Market Economy

A free market economy, or simply “market economy,” is a system in which the prices of goods and services are determined by the open market and its consumers. This type of supply-and-demand economics is only possible when there is free competition between providers of goods and services, with the various providers suing for the people’s business. In a free market economy, any provider may see a need and meet it, taking advantage of the profits it is able to generate. This is in contrast to regulated markets, in which the government controls the production and sale of goods, from the provision of raw materials, to the prices charged consumers.

In a free market economy, people are free to purchase the products they prefer, and use the services they feel most comfortable with, which allows for a healthy competition between providers. Providers then are able to adjust their prices, charging more, or lowering their prices to gain a larger share of the market. In this type of highly competitive market, private business ownership can be highly lucrative.

Laissez-Faire Economy

The idea in a laissez-faire economy is that the preferred method of operations is a system that can function free of the pressures that the government can force upon an economic system, such as taxes, subsidies, and tariffs. Laissez-faire policies in a free market economy also reject the regulation of business between private parties, as well as the implementation and forced acceptance of government-funded monopolies. In summary, laissez-faire economics believe that, the less involved the government is in the market, the better off the market will be – and, by proxy, society as a whole.

Laissez-faire economics is founded on the principle that the system is naturally self-regulating, and that self-regulation is the best form of regulation, as the government only complicates matters when forcing itself upon the situation. The only time the government is permitted to become involved in laissez-faire economics is when property, life, and individual freedoms are being threatened, requiring governmental assistance in order to be preserved. Historically, the French believed that free thought, a free market, and free competition were crucial to maintaining a healthy free society, and the success of such a society is the very example of a market economy that benefits the people.

Socialist Economics

Supporters of socialist economics argue that free markets cannot be deemed legitimately free if they are privately owned. This is because, when private ownership is a factor, differences in class, income levels, and power influence the dominant class to sway the market in their own favor; either by creating a monopoly, or by wielding more market power. Alternatively, members of the dominant class are prone to use their wealth and other resources to legislate polices that specifically benefit their own personal business interests.

Many feel that that those working in a system of socialist economics have stronger motivation to be as productive as possible, as they know they will receive a portion of the profits, in addition to what they would normally receive as fixed wages or salaries. Proponents of socialism would add that income distribution in a free market capitalist system varies widely. Such disparities require corrective measures, such as re-distributive taxation and steep administrative costs, to repair the economic instabilities that such a system can cause.

Once these corrective measures are taken, the workers no longer feel that strong drive to be productive, and they often turn dishonest, trying to evade their taxes. Government regulation is required in socialist economics in order to prevent social instability, though this same intervention is responsible for reducing the efficiency of the market economy as a whole. This is a result of the government’s need to spend more money to make up for the fact that it had failed to dole out monies as it was supposed to in the first place.

Advantages and Disadvantages of a Market Economy

Every economic system has its fair share of advantages and disadvantages. While a true market economy allows free enterprise to determine what consumers can buy, it lacks the security some feel a government-structured system provides in hard times.

Advantages of a Market Economy

  • Competition makes for increased productivity because the businesses who can afford to compete do, often earning a larger market share.
  • Originality is encouraged because it gives businesses improved chances at being competitive.
  • There is a greater variety on goods available to consumer, as businesses advance ideas to remain competitive, and lucrative.
  • People are encouraged to remain employed, so that they can afford the things they want. This, in turn, increases profits for businesses.

Disadvantages of a Market Economy

  • Money tends to generate more money, so it’s easier for rich people to get richer, than for poor people to make extra money.
  • Fewer governmental regulations controlling environmental damage keeps the costs of production lower, as environmentally-friendly production is often significantly more expensive. People suffer the effects of environmental harm.
  • Fewer governmental regulations on health and safety in the workplace also keeps costs of production down. Employees, however, suffer frequent injuries, and illnesses caused by chemicals in the workplace.
  • Social programs that are supported by taxation, such as Social Security, unemployment benefits, and Medicare, are reduced. People in need of such help find none.
  • Priorities become muddled and questionable when those in charge value profits over the needs of society.

Market Economy Example of Government Intrusion

In the 1800s, a new product found its way onto the market in the U.S. This product was called “margarine,” and was an inexpensive substitute for real butter. This product was made of animal fat, which greatly benefitted the meatpackers, and it is white in its original state. Soon, the producers found that coloring the margarine slightly yellow, so that it had the appearance of real butter, made it more appealing, therefore increasing their sales. This dyed product was called “Oleomargarine.” The dairy farmers felt threatened, as butter had become quite pricey, and many consumers simply could not afford to buy it.

Dairy farmers appealed to Congress to pass legislation placing a high tax on each pound of oleomargarine produced, which would increase its sale price on the market. Congress, at dairy farmers’ insistence, passed legislation that placed a 10-cent tax per pound on oleomargarine that was dyed yellow, in order to regulate its production. Non-colored margarine, on the other hand, was only taxed at one-quarter of one cent per pound. This legislation is known as the Oleomargarine Act.

In 1903, a man by the name of McCray, a licensed margarine dealer, purchased a 50-pound package of oleomargarine, which was falsely labeled with an IRS stamp at the rate of one-quarter of one cent per pound. McCray sold the yellow margarine at the lower price, not paying the higher tax. He was fined $50.

McCray took the matter to the U.S. Supreme Court, arguing that imposing such a high tax on the colored oleomargarine would make it so expensive to make and sell, it would not be able to compete with butter. Additionally, he claimed that Congress did not have the authority to impose what he saw as an unfair tax – thus interfering in the free market economy enjoyed in the United States.

The Supreme Court ruled in favor of Congress in a 6-to-3 decision, saying that the taxes that had been levied on both colored and non-colored margarine were both constitutional. The Court held that Congress has the constitutional authority to tax, and that its powers in this matter were “unrestrained.”

Market Economy and Employee Rights

In 1895, the state of New York passed a law called the “Bake Shop Act.” The act placed regulations on heath conditions in bakeries, and limited the number of hours a baker could work in a bakery to 60 hours per week, or 10 hours a day. In 1899, Joseph Lochner, owner of Lochner’s Home Bakery, was charged with allowing an employee to work more than 60 hours per week. He was fined $25, but in 1901 he was charged again, and fined $50 for his second conviction, and ordered to be held in the county jail until he paid the fine.

Lochner appealed his case, but the appellate court, and the New York Supreme Court ruled against him. He then took his case before the U.S. Supreme Court, claiming his right to due process under the Fourteenth Amendment had been violated. The question here was whether or not the state was fair, reasonable, and justified in interfering with a baker’s right to earn a living by limiting the number of hours he was able to work.

Related Legal Terms and Issues

  • Free Enterprise – A belief that a capitalist economy can self-regulate with minimal governmental intervention, in a market that is freely competitive, through the relationship of supply and demand.
  • Monopoly – The exclusive control over a commodity or service in a specific market, or the kind of control that allows for manipulating prices.
  • Subsidy – Money that is paid out, usually by a government, to help keep the price of a product low, or to help a business to remain in business.
  • Tariff – A tax imposed on imported goods.