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What is a 'Market Economy'

A market economy is an economic system in which economic decisions and the pricing of goods and services are guided solely by the aggregate interactions of a country's individual citizens and businesses. There is little government intervention or central planning. This is the opposite of a centrally planned economy, in which government decisions drive most aspects of a country's economic activity.

BREAKING DOWN 'Market Economy'

The theoretical basis for market economies was developed by classical economists such as Adam Smith, David Ricardo and Jean-Baptiste Say in the late 19th and early 20th centuries. These classically liberal free market advocates believed that protectionism and government intervention tended to lead to economic inefficiencies that actually made people worse off.

Market Theory

Market economies work on the assumption that forces such as supply and demand are the best determinants of aggregate wellbeing. Strict adherents to the theory rarely engage in government interventions such as price fixing, license quotas and industry subsidies. Theoretical proponents argue that central planners could not possibly gather and analyze enough information to make the optimal economic decision for all participants. Instead, each rational person with perfect information and free will should be able to maximize his well being given the set of options with which he is presented. Moreover, this allows individuals to attach different amounts of value to leisure, wealth, goods or future consumption. The personal economic value of these different aspects is known as utility. Detractors assert that the conditions that allow markets to function properly cannot hold in the real world. They contend that information is not perfect and universal; many people do not behave rationally; and corruption and uninhibited power can allow certain actors to exercise undue influence at the expense of others.

Modern Market Economies

Almost every economy in the modern world falls somewhere along a continuum running from pure market to fully planned. Most developed nations are technically mixed economies because they blend free markets with some government interference. However, they are often said to have market economies because they allow market forces to drive the vast majority of activities, typically engaging in government intervention only to the extent it is needed to provide stability.

Although the market economy is clearly the popular system of choice, there is significant debate regarding the amount of government intervention considered optimal for efficient economic operations. Nations such as Cuba, China and North Korea have been heavily influenced by the Communist theories under Marxism-Leninism, which promote coordinated economic activity and centralized planning to achieve egalitarian and shared outcomes. Such economies have struggled at times due to corruption, inept leadership, limitations to the application of these theories and trade sanctions from capitalist nations.

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