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What is a Market Economy? - Definition, Advantages, Disadvantages & Examples

What is a Market Economy? - Definition, Advantages, Disadvantages & Examples
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  • 0:04 What is a Market Economy?
  • 1:27 Advantages of a Market Economy
  • 2:11 Disadvantages of a…
  • 3:05 Examples of a Market Economy
  • 4:08 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
We live in a market economy where our well-being and quality of life are largely determined by how well we interact in it. In this lesson, you'll learn about the market economy including its advantages and disadvantages. A short quiz follows.

What Is a Market Economy?

A market economy is an economy where most resources are owned and controlled by individuals and are allocated through voluntary market transactions governed by the interaction of supply and demand.

People exchange resources, such as money, for other resources, such as goods or services, on a voluntary basis in the market. The value of the resources exchanged is based upon how scarce each resource is and how many people want the resource. If the supply of a resource is low, but the demand is high, the price will tend to be high. If the demand is low and the supply high, the price will tend to be low.

Economic growth and development in a market economy is determined by the relative risks and rewards (or profits) that particular economic activity presents to individuals. If risks are too high and rewards are too low, then certain activities probably will not be pursued.

Government involvement in regulating market transactions in a market economy is limited to pretty much ensuring that the rules of the market are enforced and applied fairly to all participants. Additionally, government involvement in planning or directing economic development and growth is very limited. In practice, there is no such thing as a pure market economy because that would mean there would be no taxes on economic activities or government regulation of economic activities at all.

Advantages of a Market Economy

A market economy has several advantages:

  • Competition leads to efficiency because businesses that have fewer costs are more competitive and make more money.
  • Innovation is encouraged because it provides a competitive edge and increases the chance for wealth.
  • A large variety of goods and services are available as businesses try to differentiate themselves in the market.
  • Economic activity is encouraged because you need money to live and need to engage in economic activity (through employment or self-employment) to make money.
  • Freedom of individual choice is possible to the extent that the market provides options for work, developing a business, and purchasing goods and services (so long as you can afford them).

Disadvantages of a Market Economy

Market economies are also not without disadvantages:

  • Disparity in wealth and mobility exists in market economies because wealth tends to generate wealth. In other words, it's easier for wealthy individuals to become wealthier than it is for the poor to become wealthy.
  • Environmental damage results with no government regulations because it's usually more expensive to produce in an environmentally sound manner, which reduces profits.
  • There tends to be a reduced social safety net, including such programs as unemployment insurance, Social Security, and Medicare, because these programs are supported through taxation.
  • Poor working conditions can result due to a lack of government regulations because health and safety cost money, thus reducing profits.
  • Questionable priorities can result when the overriding decisions regarding production are profit-motivated rather than serving the needs of the people in society.

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