What are free market economies

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By :  ,  Financial Writer

Free market economies, sometimes shortened to just market economies, describe nations whose financial systems are largely regulated by freely moving market forces of supply and demand. Learn more about how market economies operate, the political theory they’re founded on, and whether or not they work in our guide.

What is a market economy?

A market economy is a financial ecosystem consisting of private and public companies that directly determine the cost of goods and services. Private citizens also play a role in market economies by how they respond to the costs set by these companies.

In market economies that exist today, governments also play a role in preventing the formation of monopolies and protecting consumers, but they typically intervene as little as possible. This example of market economies exists in most developed nations across the world.

Free market theory

Market economies are established on the theory of free markets: that profit as a motive for private citizens and companies guides economies more efficiently than governments can.

More specifically, forces of supply and demand are expected to automatically determine the best price for goods and services. If there are gaps in what consumers need and what is available, entrepreneurs will fill those needs.

Resource allocation is determined by companies according to the profits they hope to achieve. These profits are achieved by creating finished products that consumers will value higher than the cost of resources alone. Businesses that are successful can reinvest their profit margin into future business, and those that are not will either improve or fail.

The 5 characteristics of a market economy

For a market economy to work, economists agree these five characteristics must be present.

  1. Private property

    In a market economy, most goods and services are privately owned, allowing owners to reap profits by selling those goods and services. If the goods and services provided were considered public property, no profit could be made.

  2. Freedom of choice

    Owners of private property are free to choose the characteristics of their business. However, these freedoms are limited by two market factors: the cost of producing goods and services and the price buyers are willing to pay for those goods and services.

  3. Self-interest

    Businesses in a market economy are created for the self-interest of their owners. Market economies are intended to provide opportunities for individuals to enact business according to their needs and desires. Additionally, the price of goods and services is balanced by sellers looking to make the largest profit and buyers seeking to spend the lowest amount. This creates a fair system of supply and demand.

  4. Competition

    The nature of self-interest in market economies creates a competitive marketplace. Because multiple companies can offer similar goods and services, they are forced to provide high quality while keeping prices comparably low. This competition influences the workforce as well, with workers increasing their own production to compete for the highest-paying jobs.

  5. Efficient markets

Market economies only work when buyers and sellers all have equal access to resources, prices and supplies. When every individual has equal access to a market, it is said to be an efficient market. An imbalance of these factors creates unfair competition and warps the balance of supply and demand necessary for a fair market economy.

Limited government in market economies

For these factors to exist, markets must not be overly regulated by central authorities. A government’s role in a market economy is to ensure markets are efficient and competition is fair. Tools such as price-fixing, licensing, quotas and subsidies are used by governments to ensure all businesses have a fair chance in a market economy.

Many governments in market economies establish regulatory bodies to ensure businesses are not taking advantage of consumers or producing harmful goods and services. Companies determined to be preventing competitors from supplying similar goods and services, known as monopolies, may be penalised by the government.

What is a market economy regulated by?

A market economy is regulated chiefly by supply and demand. While most real-life market economies do experience some government regulation, those governments exist to ensure equity of supply and demand. Most national economies are market economies with some degree of government involvement.

The factors of supply and demand which regulate market economies have several determinates:

Supply

Demand

Cost of production

Cost of goods and services

Number of competing companies

Cost of competing goods and services

Regulations, taxes and subsidies

Consumer’s income

Price of competing products

Consumer’s preference

Expectation of future prices

Consumer’s expectation

Market economy advantages

Market economies are favoured by many economists because of the efficiency of self-regulated and competitive systems. Economies that require little government intervention are thought to react faster to crises and require less labour than ones that require more oversight and intervention. Additionally, innovation in market economies is rewarded with profits, which many companies use to reinvest in themselves or other businesses.

Market economy disadvantages

A major disadvantage of market economies is that not everyone has equal access to resources, supplies and prices that allow for fair competition. Because of this, people who face these disadvantages are often left behind and unable to fully participate in a market economy.

The self-interest required to succeed in market economies can also have negative consequences such as encouraging individuals and companies to take actions that benefit themselves more than the majority of participants in that economy.

Modern market economies

Most countries operate with some level of a market economy. Developed nations typically combine elements of free markets with government oversight, but the vast majority of their economic activity is driven by market forces.

These developed nations also produce some public goods through sectors of government. Often these public goods and services are determined by the rights established for citizens in a nation’s constitution.

What is an emerging market?

An emerging market is a national economy that is becoming more integrated with global markets. Emerging markets are in the process of implementing free market theory to create an industrialized labour market and higher living standards for its citizens. Emerging markets will have some characteristics of developed markets such as strong economic growth, rising per capita income, liquid equity markets and a reliable regulatory system.

Companies within developing economies often emerge as players in the global marketplace, both receiving and engaging in investment opportunities with companies and investors from other nations.

You can trade emerging and developed markets through foreign exchange. The forex market is actually the most liquid market in the world. Learn more about trading forex and when you’re ready, practice trading currencies with a demo account.

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