2.9 The (Free) Market System

                             

The (Free) Market System

A market economy is an economy that has no government intervention in the allocation of resources & distribution of goods/services

This is also called a free market economy

There is no purely free market economy in the world but some countries have less government intervention than others

An economy can be considered to be a market, mixed or planned economy

The type of economy is determined by how the three economic questions are answered 

The three basic economic questions are what to produce, how to produce it, and for whom. In a market economy, these decisions are made by businesses and consumers rather than the government

This ultimately determines the amount of government intervention in an economy

Source: Heritage Foundation

 How resources are allocated in a market system?

 • private sector

 • consumer sovereignty plays a key role

 • producers respond to consumer demand

 • allocation of scarce resources in a market system is carried out through changes in the

forces of demand and supply/price mechanism

 • firms are driven by profit motive

 • prices act as a signal indicating when resources should be reallocated

 • excess demand will cause prices to rise attracting resources into this market

 • excess supply will cause prices to fall resources are reallocated out of this market

Advantages of the market economic system:

 • Efficiency — competition helps to ensure private individuals and firms pay attention to what customers want. This helps to stimulate innovation, thereby making market economies more responsive and dynamic.

 • Freedom of choice — individuals can choose which goods and services to purchase and which careers to pursue, without being restricted by government regulations.

 • Incentives — the profit motive for firms and the possibility for individuals to earn unlimited wealth create incentives to work hard. This helps to boost economic growth and living standards in the country.

Disadvantages of the market economic system

 • Income and wealth inequalities — in a market economic system, the rich have far more choice and economic freedom. Production is geared to meet the needs and wants of the wealthy, thus basic services for the poorer members of society may be neglected.

 • Environmental issues — there are negative consequences of economic prosperity under the market economic system, such as resource land depletion, pollution and climate change.

 • Social hardship — the absence of government control means that public goods such as street lighting, public roads and national defence, may not be provided. Relief of poverty in society might only be done through voluntary charities.

 • Wasteful competition — competitive pressures can mean that firms use up unnecessary resources, such as excess packaging and advertising clutter, to gain competitive advantages over their rivals. Consumers might be exploited by marketing tactics, such as pester power. The lack of government involvement could also mean that products are less safe for consumers.

Are there any reasons why a market system could fail?

Possible Reasons:

• underproduction/consumption of merit goods

 • overproduction/consumption of demerit goods 

 • non-production/consumption of public goods 

 • existence of negative externalities

 • information failure

 • existence of monopoly 

Whether government intervention in a market is always to be supported?

•merit goods will be underprovided because fewer people will consume them if a market

price is charged/people will not appreciate true value of merit goods

 • demerit goods will be overprovided because more people will consume them if a market

price is charged/people will not realise full harmful effects of demerit goods.

 • public goods will not be provided because it will be impossible to charge a price for them

 • negative externalities will be difficult to cost

 • monopoly will have control over a market, denying market competition.

✯Case Study Question:✯

Advances in technology have changed how trees (wood) are cut down, transported and used in the manufacture of furniture, such as tables. Wood is in inelastic supply. Wood can be supplied in all economic systems. However, public goods are not supplied in a market economic system. 

Explain why public goods would not be supplied in a market economic system. [4] 

Public goods are non-excludable, so it is not possible to stop people who are not prepared to pay for them from consuming them free rider problem.

Public goods are non-rival, if supplied for one, supplied for everyone and so cannot charge additional consumers.

Private sector firms are profit motivated they will not produce products if they cannot get revenue from them would make a loss.

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