🛍 Choice
Many firms compete for customers, so consumers get a wide range of goods and services. In Zorvia, a shopper may find ten different brands of headphones.
Market Economic System » The Market Economic System
What you'll learn this session
Study time: 30 minutes
Cambridge spec: 2.8.1, 2.8.2
- What a market economic system is and who owns the resources
- The advantages of letting markets decide what, how and for whom to produce
- The disadvantages, and why many people think markets need help
- How to argue both sides in an exam answer
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Unlock This CourseWhat is a market economic system?
Every stall here answers the big questions - what, how and for whom - through buyers, sellers and prices, not the government
Every country has to answer the three basic economic questions: what to produce, how to produce and who to produce for. An economic system is the way a country answers them. In a market economic system, the answers come mostly from buyers and sellers, not from the government.
Imagine the island country of Zorvia, where almost every farm, factory and shop is owned by private individuals and firms. Nobody in the government tells the farmers which crops to grow. Farmers watch prices. If shoppers want more bananas, the price of bananas rises, and farmers choose to grow more of them. This is the price mechanism you met earlier, doing the job of allocating resources.
Key terms:
- Economic system: the way a country decides how to use its scarce resources.
- Market economic system: a system in which resources are allocated by the price mechanism, with mainly private ownership and little government involvement.
- Private ownership: resources such as land, factories and machines are owned by individuals and firms, not by the government.
- Private sector: the part of the economy made up of privately owned firms and households.
The three features
💲 Price mechanism
Prices signal what consumers want, and firms follow the signals.
🏢 Private ownership
Most resources are owned by individuals and firms, who keep the profit.
📝 Little government
The government sets basic rules but does not run most of the economy.
In practice, no country is completely a market economy. This lesson looks at the system in its pure form, so we can judge its strengths and weaknesses.
Advantages of the market economic system
⚡ Efficiency
Firms must keep costs low to survive, so they avoid wasting resources. A firm that wastes resources loses customers to a cheaper rival.
💰 Incentives
Owners keep the profit and workers can earn more by working harder or gaining skills. This encourages effort and risk-taking.
💡 Innovation
Firms that invent better products or cheaper methods can win customers and make more profit, so they keep looking for new ideas.
Responds to consumers: if tastes change, demand changes, prices change and firms change what they produce, usually quickly. Resources move to where consumers want them without anyone having to give an order.
Key terms:
- Efficiency: using resources without waste, so that output is as high as possible for the resources used.
- Innovation: introducing new products or new, better ways of producing.
Disadvantages of the market economic system
The price mechanism only listens to people with money to spend, which is why markets can leave low-income families with less
The price mechanism only responds to people who have money to spend. This causes problems.
⚖️ Inequality
Those who own valuable resources or have high-paid skills earn a lot. Others can earn very little. People with low incomes get fewer goods and services, because their demand is not backed by money.
🏥 Under-provision of public and merit goods
Some goods, such as street lighting or vaccinations, are hard to sell for a profit or are not bought enough. Private firms may produce too few of them.
🚬 Over-provision of demerit goods
Goods that harm people, such as cigarettes, are produced and consumed in large amounts if there is demand and profit to be made.
🏭 External costs
Firms think about their own costs and profit. They may ignore harm to others, such as a factory polluting a river that a village uses.
👑 Monopoly power
If one firm becomes the only seller, it can charge high prices, offer less choice and ignore customers' wishes.
💼 Unemployment
Firms can replace workers with machines or close down if they are not profitable. Without government help, workers who lose their jobs may be unemployed for a long time.
You do not need the full explanation of these problems here. Later lessons on market failure look at public goods, merit goods, demerit goods, external costs and monopoly in detail.
Putting it together
A market economic system is good at giving consumers choice and encouraging efficient, innovative firms. It is poor at looking after people with low incomes, goods that are not profitable, and harm to third parties. This is why you can argue both ways, and why most countries add some government involvement.
Common mistakes
- Saying that there is no government at all. The government has a small role, such as making rules.
- Writing only a list of words, such as "choice, efficiency". Always explain how each point works.
- Giving only one side when the question says discuss. You need advantages and disadvantages.
- Mixing up the systems. In a market system the price mechanism allocates resources, not the government.
Exam-style question
In the country of Karvia, most firms are privately owned and the government rarely interferes in markets. A large mobile phone firm has become the only supplier of smartphones in the country. Some people are very rich while many families have low incomes.
(a) Define a market economic system. [2 marks]
(b) Explain two advantages of a market economic system. [4 marks]
(c) Discuss whether a market economic system is the best way to allocate resources in Karvia. [6 marks]
Model answer
(a) A system in which resources are allocated by the price mechanism (1), with mainly private ownership and little government involvement (1).
(b) Choice (1): many firms compete to attract customers, so consumers can choose between a wide range of products (1). Innovation (1): firms that create better products or cheaper methods can earn more profit, so they keep developing new ideas (1).
(c) Advantage (1): firms are driven by profit to be efficient and respond to what consumers want, which gives choice and low costs (1). Disadvantage (1): in Karvia one firm is the only supplier of smartphones, so it has monopoly power and can raise prices and offer less choice (1). Low-income families have little money to back their demand, so inequality may leave them without goods and services (1). Judgement (1): the system may work well in competitive markets, but the monopoly and inequality in Karvia suggest it is not the best way on its own.
Exam tip
For a "Discuss" part, use the context: name the monopoly and the low-income families from the question and link each point back to Karvia, then finish with a judgement.