There are four types of economies: traditional, command, market, and mixed (a combination of a market economy and a planned economy). A market economy, also known as a free market or free enterprise, is a system in which economic decisions, such as 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. These market forces influence what goods should be produced, how many goods should be produced, at what price the goods should be sold, Et al. The advantages of a market economy include increased efficiency, productivity, and innovation.
What is a Market Economy?
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In a truly free market, all resources are owned by individuals, and the decisions about how to allocate such resources are made by those individuals rather than governing bodies. Because governments have some involvement, there are no recognized economies that are 100% free.
In a free market economy, firms and households act in self-interest to determine how resources get allocated, what goods get produced and who buys the goods. A free market economy is opposite to how a command economy works, where the central gover. Market economy is based on supply and demand where the prices of goods and services are determined within a free price system. The advantages and disadvantages of market economy are described briefly below.
Key Takeaways
Business Efficiency
Unlike other types of economies, a market economy increases the efficiency of businesses. The government is limited in how it regulates transactions within a market economy. Most rules are enacted to protect consumers, the environment, market participants, and national security. Their limited role promotes increased efficiency and free and increased competition. With the existence of competition, a business tends to do whatever is necessary to lower its costs and achieve a higher number of sales to increase profits.
Increased Productivity
Increased productivity is also associated with a market economy. In any economy, people need money to purchase goods and services. In a market economy, this need leads to increased motivation because workers want to earn more money to supply their needs and to live comfortably. When people are motivated to work, there is increased productivity and output for the economy. In a command economy, where wages, levels of production, prices, and investments are set by a central authority or government, there is less 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 to gain 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.
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A free market economy promotes the production and sale of goods and services, with little to no control or involvement from any central government agency. Instead of government-enforced price controls, a free market economy allows the relationships between product supply and consumer demand to dictate prices. The lack of government control allows free market economies a wide range of freedoms, but these also come with some distinct drawbacks.
Advantage: Absence of Red Tape
For businesses, the main advantage of a free market economy is the absence of bureaucracy and red tape. This reduces administrative costs to the business; money which the company can put into other endeavors such as research and development.
Advantage: Freedom to Innovate![]()
Free market economies allow business owners to innovate new ideas, develop new products and offer new services. Entrepreneurs need not depend on government agencies to tell them when the public needs a new product. They can study consumer demands, research popular trends and meet the customer's needs through innovation. Innovation also breeds competition among firms, as each firm attempts to improve on the previous product generations by adding more and better features to existing products.
Advantage: Customers Drive Choices
In a free market economy, the customers make the ultimate decision on which products succeed or fail. When presented with two products that offer similar benefits, customers vote with their purchases and decide which product will survive. Customers also determine the ultimate price point for a product, which requires producers to set product prices high enough to make a profit, but not so high that customers will hesitate to make a purchase.
Disadvantage: Limited Product Ranges
Sine businesses are free to pursue profit in whatever way they please, goods and services that are not profitable generally will not be produced. This can limit the range of goods on offer to consumers and may impact certain groups of consumers more than others. For example, if it is too expensive to ship goods to, or open services in, rural communities then services may be withdrawn and these communities will miss out.
Disadvantage: Dangers of Profit Motive
The primary objective for any company in a free market economy is to make a profit. In many cases, companies may sacrifice worker safety, environmental standards and ethical behavior to achieve those profits. The early 2000s saw such unethical behavior run rampant at companies such as Enron and WorldCom. The Deepwater Horizon oil spill in 2010, one of the largest environmental disasters in U.S. history, was largely attributable to the use of substandard cement and other cost-cutting measures.
Disadvantage: Market Failures
When a free market economy spins out of control, the consequences can be severe. From the Great Depression of the 1930s to the real estate market crash of 2008, market failures have devastated the lives of millions in lost income, unemployment and homelessness. Many of these failures have stemmed from those seeking short-term profits over slow and steady gains, usually aided by loose credit, highly-leveraged assets and minimal government intervention.
References (2)About the Author
Living in Houston, Gerald Hanks has been a writer since 2008. He has contributed to several special-interest national publications. Before starting his writing career, Gerald was a web programmer and database developer for 12 years.
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Hanks, Gerald. 'Explain the Advantages & Disadvantages of Free Market Economies.' Small Business - Chron.com, http://smallbusiness.chron.com/explain-advantages-disadvantages-market-economies-70553.html. 01 March 2019.
Hanks, Gerald. (2019, March 01). Explain the Advantages & Disadvantages of Free Market Economies. Small Business - Chron.com. Retrieved from http://smallbusiness.chron.com/explain-advantages-disadvantages-market-economies-70553.html
Advantages Disadvantages Of Free Market Economy
Hanks, Gerald. 'Explain the Advantages & Disadvantages of Free Market Economies' last modified March 01, 2019. http://smallbusiness.chron.com/explain-advantages-disadvantages-market-economies-70553.html
5 Advantages Of Free Market Economy
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