Market Economic

system
Remember: All economic systems must answer the
three fundamental questions:
 What to produce?
 How to produce it?
 For whom to produce?
Because of the basic economic problem.
What it is a market economic system?
This economic system relies on the market forces of
demand and supply (in the private sector) to allocate
resources, with minimal government intervention. It
answers the three fundamental economic questions in
this manner:
 What to produce? This is determined by the
consumers preferences, and these preferences are
signaled to the producers through the price
mechanism.
 How to produce it? This is decided by the private
sector firms, and the decision made about what
FOP employ when producing a product (i.e. the
decision about how to produce a product) will
usually be based on the lowest costs and highest
quality. For example, when firms choose
whether to use labor-intensive or capital-
intensive techniques, they will choose the lowest
cost technique.
 Who is to receive the products produced? The
consumer’s buying power (i.e. the greater the
 income of consumers the greater the chance of
receiving products)

The nature of the market economic system

1. In a market economic system, the resources are
always moving towards the production of
different products according to changes in price,
and the changes in price in turn are determined
by the interaction between demand and supply
(price mechanism)
2. There is a large number of firms causing
competition (competitive pressure), which has
many benefits:
 It creates choice for consumers. If there is a
large number of firms producing a product,
there will be a lot of options (producers) to
choose from.
 Consumers will be sovereign. The greater the
number of firms the greater the likelihood of
consumer deciding what is made, causing the
 producers to compete with each other to meet
the consumer’s demand.
 Competition, whether it was actual or
potential, results in lower prices. If it is
possible for consumers to switch from firms
that set high prices to ones which set lower
prices (if there is competition), then there will
be pressure on firms to keep their prices low to
not fail and stay in business.
3. A market economy keeps businesses efficient. It
does this by rewarding those business which
quickly respond to market changes and signals
and punishes those who don’t. It provides both a
carrot (reward) and stick (punishment) to
promote efficiency. The way this works:
 For businesses: if a business is efficient and
responds to demand changes quickly it is
likely to earn profits (the carrot). And if a
business is unresponsive to demand changes,
then it is likely to suffer losses (the stick).
 For labour markets: if workers are efficient
(developing skills in high demand, work hard,
accept more responsibility, and are willing to
change their nature of work) they are more like
to earn high wages (the carrot). Those workers
however who aren’t prepared, or able to, be
efficient will probably receive low incomes or
even be let off from their jobs.