An economic system where prices, wages, and what is made and sold are determined by market forces of supply and demand, with no state interference. The contrast is with a command economy, where the state takes all economic decisions. Most Western economies these days are mixed, with varying degrees of state control.
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A market economy (also called a free market economy, free enterprise economy) is an economic system in which the production and distribution of goods and services takes place through the mechanism of free markets guided by a free price system rather than by the state in a planned economy. In a market economy businesses and consumers decide what they will produce and purchase, as a opposed to a planned economy where the government decides what is to be produced and in what quantities.
A market economy has no central coordinator guiding its operation, yet theoretically self-organization emerges amidst the complex interplay of supply and demand and price regarding a multitude of goods and services. Supporters of a market economy generally hold that individuals pursuing their self-interest through trade has the incidental effect of bringing about a spontaneous order that is effective in supplying the greatest abundance of goods for society and in the most efficient manner. The theoretical model of a large-scale free market economy does not occur legally, however the underground economy may be seen as an actualized free market economy.
Free market economy
There is currently no state where all markets within its borders are absolutely free. Less market restrictions are found in other countries, such as in Hong Kong, according to the Index of Economic Freedom. Free markets are also conflated with anarchy as many people believe that free market implies an absence of government. These scholars debate and disagree with each other on whether or not governments are necessary to have government funded roads, schools, post offices, libraries, police stations, and fire stations, as some free market scholars believe the market can solve their externalities.
In order for an economy to be considered a true free market, the factors of labor, goods, services, and capital, must be free from government restrictions and trading barriers so they are able to move freely across borders.
Generally market economies are bottom up in decisionmaking as consumers input information to producers through prices paid when purchasing products on the market.
Market externalities
Examples of market failures, or externalities, include negative externalities, monopolies, lack of provision of public goods, and social disparities such as extreme poverty.
Government intervention
It is possible for a market economy to have government intervention in the economy. The key difference between market economies and planned economies lies not with the degree of government influence but whether that influence is used to coercively preclude private decision. In a market economy, if the government wants more steel, it collects taxes and then buys the steel at market prices. An economy where both central planning and market mechanisms of production and distribution are present is known as a mixed economy. Germany's social market economy was one of the better functioning mixed economies, as microeconomists note that it had relativily free prices compared to other more socialist countries like the United Kingdom for much of the later 20th century.
The proper role for government in a market economy remains controversial. Most supporters of a market economy believe that government has a legitimate role in defining and enforcing the basic rules of the market. More controversial is the question of how strong a role the government should have in both guiding the economy and addressing the inequalities the market produces.
Market freedom
Friedrich von Hayek and Milton Friedman stated that economic freedom is a necessary condition for the creation and sustainability of civil and political freedoms. They believe 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 prices and private property rights.
Friedman states:
"economic freedom is simply a requisite for political freedom. 2-3
Studies by the Canadian "conservative" free market oriented Fraser Institute, the American "conservative" free market oriented Heritage Foundation, and the Wall Street Journal state that there is a relationship between economic freedom and political and civil freedoms to the extent claimed by Friedrich von Hayek.
Markets and communist states
In the 1980s, most of the planned economies in the world attempted to transform themselves into market economies, for various reasons and with varying degrees of success. In the Soviet Union, this process was known as perestroika while in China the creation of a "socialist market economy" was one element of Chinese economic reform.
Despite being the largest country whose ruling party refers to itself as communist, the People's Republic of China runs Special Economic Zones dedicated to capitalist enterprise, which are free from central government control.
These Special Economic Zones have few restrictions upon businesses, industries, imports and exports, including the elimination of duties, and a free price system. SEZ's operate under market economy rather than the state capitalist top down command economy approach.
According to China.org "After opening Shenzhen and other three coastal cities in South China as special economic regions and then dozens of economic and technological development zones in the 1980s, the country introduced free trade zones in the early 1990s in 15 coast cities, including Shanghai, Guangzhou, Shenzhen and Tianjin."
Criticism of market economy
There are a variety of critics of market as an organizing principle of an economy. These critics range from those who reject markets entirely, in favor of a planned economy, such as that advocated by socialism, to those who merely wish to see them regulated to various degrees, and they range from those who believe that greed is inherently immoral to those who raise practical objections.
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 fulfill the needs of the market participants.
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