Characteristics of the Market Economy
Limited role of the state. The market economy is not planned, controlled, or regulated by the government. The government satisfies collective wants, but it does not compete with private firms: nor does it tell the people where to work or what to produce. In a strictly market economy, the only major role performed by the government would be that of creating a framework of rules within which both private individuals and firms could conduct their affairs.
Use of price mechanism. In a market economy, there is a reliance on the price mechanism to allocate resources. Decisions about consumption are undertaken by different people, each freely expressing preferences for different goods and services,, Producers who freely decide which goods and services they are going to provide undertake decisions about production.
There is hardly any direct communication between each of these groups, and yet any change in the preferences of consumers is quickly transmitted to producers via its effect on the prices of the goods and services which producers provide. This is referred to as the Invisible hand. These price changes ensure that the decisions of consumers and producers, although taken independently, are usually compatible with one another.
For instance, if a good suddenly becomes more popular so that there is a market shortage at the existing price, price will rise so as to ration the available supply. The rise in price will make production of that commodity more profitable. Output will therefore increase, as producers are now able to attract resources away from alternative uses by the offer of higher rewards. If the commodity becomes less popular, the price will fall and the production of the commodity reduces. It should be noted that changes consumer demands lead to changes in the allocation of resources. Due to this, therefore, the consumer is said to be sovereign in market economies.
Consumer sovereignty means that market outcomes reflect the desires of the consumers. Consumers determine what and how much shall be produced in an economy.
The right to own and dispose off private property. The factors of
production are privately owned, and production takes place at the initiative of private enterprises. Any individual possessing the necessary factors is free to undertake production. 'In the absence of government intervention, they are free both to undertake production and to decide what they will produce. Those individuals who undertake production are known as entrepreneurs.
production are privately owned, and production takes place at the initiative of private enterprises. Any individual possessing the necessary factors is free to undertake production. 'In the absence of government intervention, they are free both to undertake production and to decide what they will produce. Those individuals who undertake production are known as entrepreneurs.
The existence of the profit motive. In making decisions about production, entrepreneurs are often guided by the profit motive. The motivating force for the entrepreneur is assumed to be self-interest. Entrepreneurs produce whatever offers them the greatest profit. Because of this, price changes provide signals to producers, and because of the effect of price changes on profit, producers react to these signals.
Role of price mechanism in a free enterprise economy: It is a system of economic organisation in which each individual - consumer, producer, resource owner - is engaged in economic activity with a large measure of freedom. In this system, resources are privately owned. The price system functions through prices of both goods and services.