A market economy is a system in which the economic decisions and the prices of goods and services are determined by supply and demand. The assumption behind a market economy is that supply and demand are the best determinants for an economy's growth and health. The advantages of a market economy include increased efficiency, productivity and innovation.

Business Efficiency

Unlike other types of economies, a market economy increases efficiency of businesses. The government limits its involvement in regulating market transactions in a market economy. The lack of heavy government intervention leads to competition and increases efficiency. With the existence of competition, a business tends to do whatever is necessary to lower its costs and achieve a higher number of sales and increase its profit. (For related reading, see: The Amateur Investor's Guide to Analyzing Corporate Efficiency.)

Increased Productivity

Increased productivity is also associated with a market economy. In a market economy, people need money to purchase goods and services. Generally, this leads to increased motivation, because workers want to earn more money to live comfortable lives. When people are motivated to work, there is increased productivity and increased output for the economy. In a command economy, where wages are set and desirable products may be in limited supply because the government doesn't consider them important enough produce, there is not as much worker motivation.

Innovation for a Competitive Edge

A country with a market economy also has increased innovation. With money as the main motivating factor for firms and individuals, they look to create new products and technologies to generate higher incomes. In a market economy, firms and individuals are encouraged to innovate products because they provide a competitive edge. This is different than a command economy, where the government controls production, including supply and demand, so there is no reason for companies to compete. Innovation also leads to a variety of goods and services, which provides a wider selection for consumers. (For related reading, see: Why Innovation Is Crucial to Business Success.)

  1. What's the Difference Between a Market Economy and a Command Economy?

    Set by supply and demand, a market economy operates through a price system; in a command economy, governments control the ... Read Answer >>
  2. To what extent can a government intervene in a market economy?

    Find out at what point a market economy receives so much government intervention that it can no longer be considered a market ... Read Answer >>
  3. How is an economy formed and why does it grow?

    Find out how an economy forms and why it grows, including the role that financial markets play and how productivity increases ... Read Answer >>
  4. What are some examples of free market economies?

    Hong Kong, Singapore and Australia are examples of free market economies. Read Answer >>
  5. Is demand or supply more important to the economy?

    Learn more about the impact of supply and demand in an economy. Find out why companies study supply and demand as part of ... Read Answer >>
  6. How do economies of scale work with globalization?

    Discover how globalization can lead to unprecedented economies of scale for firms across the world, leading to higher global ... Read Answer >>
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