A market economy is defined as an “economic system, which resolves the basic economic problem mainly through the market mechanism. ” There are four main type of actors within the system which are consumers, producers, owners of private property and the government. In a pure market economy, it is argued, that consumers, producers and property owners are selfish in that all their decisions are based upon private gain and maximising their individual welfare. For example producers strive to maximise profit whereas the owners of production aim to maximise rent, wages and profits.
Adam Smith argues that although economic actors pursue their own self-interest, the result would be an allocation of resources in the economy, which would benefit the society as a whole, and he refers to this concept as “the invisible hand. ” However it is presumed that the government is motivated to act in the best way possible for the welfare of the community as a whole and not personal gains. In market economy owners of the factors of production as well as producers have the right to buy and sell what they want and when they want, through the market mechanism.
Therefore strong competition will exist. Producers compete for the spending of consumers and workers compete for employers and jobs. In a market economy decision making is decentralised. By this it is meant that there is no single body, which allocates resources within the economy, rather the allocation is the result of many decisions made by individual economic agents. In a free market it is the consumer which determines the allocation of resources. Each consumer has a certain amount of money, which they use as a means of exchange for goods and services.
Their spending enables firms to but the factors of production needed to produce the good or service. The increases in demand of a good will increase its price. Therefore the manufacturers of that good will earn abnormal profit ie profit above and over what is normal in that industry. They will respond to this by increasing production. This will consequently lead to new firms producing the good, which will expand supply and create competition. This will force prices down to a level, which is high enough for a suitable profit, but low enough to deter or discourage new suppliers from being attracted onto the industry.
Profits are extremely important in a market economy. They act as a signal for what is to be produced. If firms are earning abnormal profits then it is signal that consumers wish to buy more of that product and vice versa. All other things being equal, consumers will buy from the producer who offers the lowest price. So producers must produce at the lowest price possible and hence in a free market there is productive efficiency-ie a firm will use the factors of production carefully and effectively e. g. they won’t hire 20 workers when 10 can easily do the job.
Although, in a market economy, the government places few limits and restrictions on what can be brought, sold and at what price, the role they do play is extremely important and crucial in maintaining of a market structure. Some goods, called public goods, are not provided by the market, such as the emergency services which the government is responsible for and which they pay through taxes. Other goods and services such as education and healthcare is provided by both the state and the market. The government is also responsible for the issue of money and for the maintenance of its value.
They also have to ensure a adequate legal framework for the enforcement of property rights. But in a free market there is strong emphasis on the government playing as much of a minimum role as possible. A market economy has many merits as well as demerits. There is a lot of choice for the consumer on a wide range of goods. However it is argued that this choice is not available for all. Those on high incomes have a lot of choice in the goods and services they want whereas those on low incomes have little choice.
In a market economy there may be a variety of goods, but they will also be out of the price range of the poorest in society who don’t have the ability to pay for it. Economists have also argued that a advantage of a market economy is the strong competition that is prevalent between producers and suppliers. The presence of a large number of buyers and sellers thus ensures that power is diffuse and not concentrated in the hands of a few. However in reality, over the years, the market has tended to become dominated by a few large producers e. g. Virgin.
In a market economy strong incentives are built into the system to innovate and produce high quality goods and services. Another merit of the market economy is that producers must be efficient because if they are not they will either make huge losses or will be driven out of business by other companies. Also market economies are very dynamic as shown by Japan which has grown faster than the USA over the past thirty years. However market economies have no link between need and allocation of resources, e. g. food will be sold to the person who can pay for it rather than those who are starving and will die if they don’t get anything to eat.
In a market economy many people are likely to have a little or no income at all through no fault of their own. Examples of these groups are the old and handicapped. Individuals take great care to reduce the risks associated with a market economy, they can insure themselves against sickness and unemployment. However yet again this is limited to those that can afford the monthly premiums. Ultimately a market economy segregates society into two groups, the rich and the poor. It makes the rich richer, and the poor, poorer.
Thus it seems that the advantages of a market economy are not as simple and as great as they first appear. In the late 1940`s and early 1950`s, Eastern European countries became command economies, following communist take-over. However since the 1990`s they have transferred themselves into more market economies. It is inevitable that such a dramatic transition would reduce output. In the 1990-2 recession in the UK, GDP which is gross domestic production fell by 3. 7%. (GDP is the most commonly used measure of national income before property income from abroad has been accounted for. This was enough to double unemployment from 1. 6 million to 3 million. In 1992-4, Georgia was in the mist of a civil war, which on top of restructuring their economy, made their GDP fall to less than one fifth of its 1990 value. The fall in output of each East European country during the transition period was because of the fact that the sate owned businesses lost customers as the old network between businesses fell apart. The reason for this was because it was all based on state planning, the government told each firm which other firm would receive their output and they would be paid accordingly.
They would also be told where it should buy its inputs. During the transition period firms had to actively seek customers whereas before they were handed to them on a platter. Also firms may have decided to import the produce from cheaper sources in the west, which they may have been forbidden to do before. This will mean that suppliers will lose customers’ overnight with little chance of regaining them since the world is now their oyster. All this caused great problems for the countries in East Europe. One of the strengths of a planned economy is that there is virtually no unemployment.
So when East European countries moved to a more market structure, there was a large shake-out of labour. Many businesses and factories were forced to close down and there was a huge increase in unemployment levels. For example, unemployment in Poland rose from 0. 3% in 1988 to an estimated 15. 0& in 1996. Enterprises were forced to become more efficient, even more so because of competition from the west. Efficiency is easily gained by shedding labour and making the remaining workforce work harder and more productively. The transformations in Eastern Europe have been associated with high inflation.
A rise in price is almost inevitable if an economy moves towards a free-market system. In a market system resources are allocated by price. The free market price is inevitably higher than the old state price since consumers have been rationed in the past so demand will be greater. So when a market system is introduced price will rise until demand equals supply. There is no shortage because some consumers have been priced out of the market. Higher prices can spark a wage price spiral. Workers in Eastern Europe have reacted to higher prices of goods by demanding higher wages.
If firms give higher wages then they must make up for the cost by increasing the price of their goods, which will in turn, gives a rise to further wage demands. The government must then give firms money to pay the workers and to prevent them from going bankrupt. If they don’t they will have protests, strikes and civil unrest to deal with, whereas if they print too much money it will simply make it worthless. In a command economy land and capital is owned by the state, whereas in a market economy it is predominantly owned by the public sector.
S o the move from one type of economy to the other involves the sale of state assets to private individuals -privatisation. This can be done by a number of ways, such as give property and capital away to individuals and companies currently employing them, e. g. tenants of council housing could be given their accommodation. The problem with this is that it is a very arbitrary and unfair way of sharing out the state owned businesses and capital. This would divide society into the rich and poor. The state could also sell its assets to the highest bidder and use the proceeds to reduce tax or reduce government debt.
Despite all these problems the change was necessary for two main reasons. Firstly the command systems were based on repressive political structures that could only be run at the expense of personal freedom. They rely on ordering people to take certain actions, they are very autocratic. To regain personal freedom individuals had to regain economic freedom. This necessitated a move to a more market orientated economy. Secondly in planned economy production was very inefficient, shops were all too often empty. Goods and services that were produced were of a poor quality.
Workers were getting second, often illegal jobs, which they worked much harder in since they did so little in their official state job, e. g. 100 workers were employed when 50 could have done the job. Therefore the decision to become a market economy was an attempt to be efficient and produce high quality goods. In conclusion the problems faced by East European countries were inevitable as such a change, from an autocratic to a lassiez e faire structure could not be accomplished without any teething problems. All the companies and individuals needed time to find their feet and explore their new-found freedom and independence.