Pros & Cons of Market Economies

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Supply and demand determine what's produced in a market economy.
Supply and demand determine what's produced in a market economy. (Image: stu99/iStock/Getty Images)

Market economies strive for a minimum of government regulation in the business sector and rely on consumer supply and demand to make production decisions. As opposed to a planned economy, in which the government has significant influence over what’s produced, a market economy is composed of willing buyers purchasing products from willing sellers based on what the market will bear with minimal interference. In practice, however, virtually all economies have some restrictions on the free market to balance the pursuit of profit with public welfare.

Freedom to Succeed

The central advantage of a market economy is that it allows businesses the freedom to compete for customers with minimal restrictions, with a government that enforces the laws but otherwise does little to inhibit business operations. While virtually every government assumes a role in influencing how businesses operate domestically, fewer restrictions generally provide more flexibility for companies to operate. Businesses provide what the customers demand and have an incentive to do so quickly before a rival steps in to fill that void. With few restrictions on labor or capital movement, a company can form quickly or retool to meet new market demands. If its customers decide they don't want to buy widgets any more, a business in a market economy can retool its factories to produce other items with a greater profit potential.

Improved Products

In a market economy, the threat of competition drives the constant need to improve the quality and function of a product or service. With no government support for one company over others -- as might occur in a state-run economy, where business is steered toward one or two providers -- a business that fails to meet customer demands can become vulnerable quickly. Market forces discourage complacency and encourage a constant search for “the next big thing” -- a new product or service that meets an unmet customer need.

Efficient Use of Resources

In theory, a market economy makes efficient use of labor and capital because of its focus on profit potential and return on investment. A government that subsidizes a particular industry, by contrast, encourages resources to be spent on that industry even if they could be redeployed more productively in other areas. For example, a country in which the auto industry is heavily subsidized encourages the production of cars even when it might be cheaper to import vehicles and use labor and capital resources elsewhere. A market economy, in theory, could use the labor more productively, perhaps for producing television sets or music players. In practice, many market economies do subsidize certain industries as an incentive to research and develop products and services.

Dominance Has Its Price

In a market economy that features minimal government influence, a business can acquire or eliminate the competition and become a monopoly if it has the capital to do so. For example, it can sign exclusive contracts with all major distributors to keep its rivals from having the opportunity to secure a national market to sell its wares. This approach can create barriers to entry that are too high for new businesses to cross, effectively stifling innovation. That's also bad for the consumer, because without that competition, the monopoly company can increase its prices and the customer might have little choice but to pay them.

Societal Needs Unmet

The sole basis of a market economy on consumer demand and ability to pay can result in certain communities or social functions being underserved or ignored and short-term demands trumping long-range planning. For example, if demand for housing is high, a market economy might see all area farms converted into new housing units regardless of the long-term effects on the local food supply. A similar emphasis on consumer goods could leave little funding for defense, education, health care and social programs that improve the quality of life and economic opportunities for the less advantaged.

Far-Ranging Impact

A market economy that focuses only on short-term success can have far-reaching negative impacts. For example, a business might logically prefer to set up factories in countries with little to no environmental regulations as a more cost-effective solution that doesn't require the business to spend money on green technologies or environmental compliance. But the resulting pollution can have devastating global effects, particularly if it contributes to accelerated climate change. A government that doesn't regulate the "free market" in oil and energy exploration and production, for example, can find itself under fire from its citizens for resulting earth and groundwater contamination.

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