Academia de Studii Economice Facultatea de Comert

The Characteristics of Market Economy

Lector doctor: Autori: Virginia Mihaela Dumitrescu Precup Corina Proca Raluca Radu Stefan Rotaru Simona Saviuc Alin

Bucuresti - 2011- The Market Ecomony

The market economy, also called free market economy or free enterprise economy is, probably, the best substitute for economical freedom. Among history we had many examples of different types of systems, like socialist, capitalist or planned economy but the one who seemed to function most was the market economy. People embrace it because it gives them the freedom, as a producer, of choosing what goods to produce, how, when and to whom to sell them, and as a consumer, it offers the opportunity also to choose between competing goods and services and freedom as a worker to choose among different jobs or careers. Basically, it goes by the principle of competition, where every seller has to lay out his merchandise at a price established by the market itself. In the real world, market economies do not exist in pure form, as societies and governments regulate them to varying degrees rather than allow full self-regulation by market forces. The term free market economy is sometimes used synonymously with market economy, but, as Ludwig Erhard once pointed out, this does not preclude an economy from having social attributes opposed to a laissez-faire system.

The principles of market economy

1. Free markets - the production and distribution of goods and services takes place through the mechanism of free markets.In a market economy, the price of each product is established according to a mutual consent between the buyer and the seller, in opposite to the planned economy where the price, quantity and distribution of products are set by the government, which practically controls the market.

2. Free price system - the prices are set by the interchange of supply and demand, meaning the matching of the sellers asking prices with the buyers bid prices, as a result of subjective value judgment. Is an economic system where prices are set by the interchange of supply and demand, with the resulting prices being understood as signals that are communicated between producers and consumers which serve to guide the production and distribution of resources. Through the free price system, supplies are rationed, income is distributed, and resources are allocated. A free price system contrasts with a controlled or fixes price system where prices are set by government, within a controlled market or planned economy.

3. The interplay of supply and demand - The theory of supply and demand is important in the functioning of a market economy in that it explains the mechanism by which many resource allocation decisions are made. Basically, in a market economy the relation between the supply and the demand establishes its direction, the prices and the eventual risks both parties may take when engaging in an interchange process. Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unite price for a particular good will vary

until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.

4. Producers self-interest - By following their own self-interest in open and competitive markets, consumers, producers, and workers are led to use their economic resources in ways that have the greatest value to the national economy -- at least in terms of satisfying more of people's wants. The first person to point out this fact in a systematic way was the Scottish philosopher Adam Smith, who published his most famous book, An Inquiry Into the Nature and Causes of the Wealth of Nations, in 1776. Smith was the first great classical economist, and among the first to describe how an economy based on a system of markets could promote economic efficiency and individual freedom, regardless of whether people were particularly industrious or lazy. It has been proved among the years that the production quality and quantity reaches its best when people produce not only for the common good but, especially, for their own good. Self-interest serves as an important factor which motivates the producers to use their resources more efficient, in the purpose of expanding their enterprise or simply raising more money.

5. No government intervention - the role of government is not to take the place of the marketplace, but to improve the functioning of the market economy. Further, any decision to regulate or intervene in the play of market forces must carefully balance the costs of such regulation against the benefits that such intervention will bring. In a market economy, the government interferes only to prevent market failure, maintain stable currency and thus combating the inflation, and protect market competition and the consumers. Nevertheless, its intervention must be limited, in order not to influence the two parties the buyer and the seller, nor the market price or products distribution.

One important point to bear in mind is that the effects of different forms of government intervention in markets are never neutral – financial support given by the government to one set of producers rather than another will always create “winners and losers”. Taxing one product more than another will similarly have different effects on different groups of consumers.

6. Competition - In a free market economy, competition works to ensure the efficient and effective operation of business. Competition also ensures that a firm will survive only if it serves its customers well.

Competition in economics is a term that encompasses the notion of individuals and firms striving for a greater share of a market to sell or buy goods and services. Merriam-Webster defines competition in business as "the effort of two or more parties acting independently to secure the business of a third party by offering the most favorable terms." It was described by Adam Smith in The Wealth of Nations (1776) and later economists as allocating productive resurces to their most highly-valued uses, and encouraging efficiency. Later microeconomics theory distinguished between perfect competition and imperfect competition, concluding that no system of resource allocation is more Pareto efficient than perfect competition. Competition, according to the theory, causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater selection typically causes lower prices for the products, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly). A monopoly is a market structure in which there is only one producer/seller for a product. In other words, the single business is the industry. Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political. For instance, a government can create a monopoly over an industry that it wants to control, such as electricity. Another reason for the barriers

against entry into a monopolistic industry is that oftentimes, one entity has the exclusive rights to a natural resource. For example, in Saudi Arabia the government has sole control over the oil industry. A monopoly may also form when a company has a copyright or patent that prevents others from entering the market. In an oligopoly, there are only a few firms that make up an industry. This select group of firms has control over the price and, like a monopoly, an oligopoly has high barriers to entry. The products that the oligopolistic firms produce are often nearly identical and, therefore, the companies, which are competing for market share, are interdependent as a result of market forces. Assume, for example, that an economy needs only 100 widgets. Company X produces 50 widgets and its competitor, Company Y, produces the other 50. The prices of the two brands will be interdependent and, therefore, similar. So, if Company X starts selling the widgets at a lower price, it will get a greater market share, thereby forcing Company Y to lower its prices as well. There are two extreme forms of market structure: monopoly and, its opposite, perfect competition. Perfect competition is characterized by many buyers and sellers, many products that are similar in nature and, as a result, many substitutes. Perfect competition means there are few, if any, barriers to entry for new companies, and prices are determined by supply and demand. Thus, producers in a perfectly competitive market are subject to the prices determined by the market and do not have any leverage. For example, in a perfectly competitive market, shoulda single firm decide to increase its selling price of a good, the consumers can just turn to the nearest competitor for a better price, causing any firm that increases its prices to lose market share and profits.

Bibliography:

◦ The Characteristics of the Market Economy - Ludwig von Mises, Human Action: A Treatise on Economics, vol. 2 (LF ed.) [1996]

◦ Www.wikipedia.org