Market Economies

The market economy is also referred to as the free enterprise economy or capitalist economy. It is an economic system which resolves the basic economic problem mainly through the market mechanism.

The main players:

Motives

In a pure market economy, the underlying motive for people’s decisions is self-interest, with decision being based upon private gain. Consumers will aim to maximise their individual utility, whilst producers will aim to maximise profit. The owners of the factors of production will aim to maximise the rewards to these factors, in other words wages, rent interest and profit.

On the other hand, government is assumed to be motivated by considerations of the good of the community and not self-interest.

Private Ownership

Nearly all factors of production within the economy are owned by private individuals and organisations. The Government will be called upon to enforce the rule of law and the rights of citizens.

Free Enterprise

Owners of factors of production, as well as producers of goods and services have the right to buy and sell what they own through the market mechanism. In a pure free market government intervention is kept to a minimum, and restrictions on what can be bought and sold are limited. Workers can work for whom they want, and buy, rent or sell property (homes) in addition to being able to establish their own businesses. Consumers can use their money in any way they wish, and produce what ever they find on offer. Producers are able to sell anything they like.

Competition

Competition will exist because individuals and firms are free to allocate resources in anyway they wish. Consumers will have spending ‘votes’, which they will be able to cast throughout a high street on the goods on offer. Producers will compete in order to capture those votes. In order to borrow money, individuals, firms and government will compete in the financial market.

Decentralised decision making

There exists no single body to decide how resources are allocated, rather the allocation of resources is the result of countless decisions by individual economic agents. Adam Smith argues that an invisible hand (moral conscience) operates over the economy and allocates resources with the best interests of society at heart.

The Market Mechanism

The market Mechanism seeks to answer a number of questions:

1. What is to be produced?

In a pure free market, it is the consumer which determines the allocation of resources. Consumers are sovereign. Each consumer has a certain amount of money to spend, their income or savings. This will then be allocated across certain purchases, each £1 is like a vote. It acts as a vote of confidence in a product and encourages greater production. Firms will receive these votes and in turn purchase new factors of production enabling the firm to produce more.

Consumers make spending decisions based upon their individual choices. These decisions will affect the entire economy. For example if consumers decided to spend less on holidays and more on clothing, then it is likely that demand will go up, profits will also go up so that firms earn super-normal profits. New firms enter the clothing market adding to supply. Once the market gets saturated prices start to fall until some firms make losses and go bankrupt. Eventually the market will return to equilibrium allowing firms to make a reasonable profit. On the other hand the holiday firms will experience a fall in demand. This will result in a price war as firms compete with one another for the dwindling number of customers left in the market. Some firms will go bankrupt as profits decline. This will continue until holiday firms can start to earn a profit to prevent firms leaving the industry.

2. How is it produced?

Producers are in competition to win customers. Consumers, all things being equal, will buy from the cheapest producer. Thus producers must produce at lowest cost if they are going to sell anything and survive. This will determine the method of production, and hence result in the free market operating at the productively efficient point.

3. For Whom ?

Consumers spend money, the amount of money being determined by that individuals income and wealth. In a free market, this is determined by the ownership of the factors of production. Workers will receive rewards in the form of wages, for the sale of labour. Owners of land will receive rent in return for allowing their land to be used. Therefore those with high incomes and great amounts of wealth are able to buy large quantities of goods and services. The opposite is true of those on low incomes, and therefore small budgets. In a market economy it is the case, that the wealthy gain a disproportionate share of what is produced, whilst the poor get relatively little.

 

The Role of Government

1. Some goods cannot be provided by the market mechanism. These are known as public goods. Such examples are street lighting, light houses, police, defence and the judiciary. These the government must pay for; to do so it must raise revenue through taxation.

2. The government is responsible for the issue of the currency and its stability. In addition it will have a role to play in maintaining stable prices, i.e. minimise inflation.

3. The government must ensure that an adequate framework exists and is implemented to maintain property rights of individuals. If people are allowed and encouraged to maximise their self-worth, they must be able to protect it against for example theft, negligence and wanton destruction

4. Property rights must be allocated an economic unit in society. Otherwise goods will be treated as free goods (a good in unlimited supply e.g. air) and consumed until satisfaction is maximised (Marginal Utility is 0). An example of this is pollution, where organisation were not held to account for pumping toxins into the atmosphere. This meant they continued to do so not caring about the effects. In contrast people would not perform such acts of destruction against their own property. Organisations are now fined for excessive pollution, which in addition is restricted through fiscal means such as a Carbon tax.

5. Governments will also act to ensure that economic markets operate smoothly. Firms or trade unions may seek to gain control over individual markets and create monopolies. Government has the power to break-up monopoly which may be anti-competitive.

Without government to regulate, introduce and enforce legislation there would be anarchy. However a free market assumes the price mechanism will establish what is needed and deliver it, thus making the role of government negligible. Government regulation should be kept to the minimum in order to secure the orderly working of the market economy, and therefore to that end government spending should be kept to a minimum and directed at public goods.

 

Free Market Economy: A Summary

Choice:

In a rich free market economy, consumers should be faced with very wide choices. Firms will compete on either on either price if the good is homogenous (i.e. similar), or on a wider range of factors, such as packaging or marketing if the competing goods are non-homogenous (not similar). Although there may be large choice, this choice need not be available to all. For example those on low incomes will not be able to access all the goods and services available in the economy, because they can’t afford them.

Quality and Innovation

A free market includes inbuilt incentives and motivators to improve quality and innovation in the form of profit. Companies which fail to improve quality and constantly innovate will find that they lose market share to competitors and eventually could go bankrupt. In reality because some markets are controlled by big manufacturers who have consumers tied to them it is possible that innovation and quality might not be as great as otherwise, yet it should be better than that experienced under a planned system. For example, the electrical goods market is dominated by a few small retailers, and consumers can often take it or leave it.

Economic Growth

Free markets are often dynamic economies. The USA, a typical free market has grown rapidly since WWII, yet not as quickly as Japan. In addition many mixed economies have grown as quickly, if not quicker than the USA’s. Therefore a free market is not necessarily a passport to quick economic growth, but it can aid it.

 

Distribution of income and wealth

In a pure free market, resources are allocated to those who can afford them. The socially disadvantaged groups in society with no income will be unable to afford the resources required to survive and will pay the ultimate price of death. These groups, including the handicapped, illiterate, orphaned or old are involved in a struggle in which only the fittest survive.

Free markets will argue such apocalyptic professes should be taken with a pinch of salt. There will exist a safety mechanism for the disadvantaged – charity. The wealthy will contribute, in order to clear their conscience or out of civic duty, so that the less fortunate might eat and live. In addition people are encouraged to prepare for the future in the form of pensions, life insurance, medical insurance, critical illness, and nursing cover to assist in any eventuality which forces people out of work and into social deprivation. The fact that such preparation is a necessity is symptomatic of society’s unwillingness to assist one’s fellows when they are in distress. Ultimately the unemployed can starve; the sick die for lack of finance, and the homeless freeze to death on the streets. A free market society is about allocation of resources to the wealthiest, be it mentally, financially or physically resulting in a Malthusian survival of the fittest and strongest in society, and thus a form of self-selection.

Risk

A free market, as with anything carries some risks. Society does not help those who don’t help themselves, and so the risk is that one becomes unemployed, too sick or too old to work, and thus financially less well off. To avoid this eventually the free market has plugged the gap in the market (where there is a demand the market provides) by providing insurance for sickness, old age, unemployment, or death.

However, only a few have the insight or financial wherewithal to insure themselves adequately. In practice, the poor remain poor, perhaps unable to support themselves or dying through lack of medical treatment.