What is market economy?

A market economy is an economic order in which both planning and control of all economic processes are coordinated via markets with the help of price mechanisms. The task of the state lies primarily in the definition of suitable framework conditions with the help of which the competition can be coordinated in a meaningful way.

In this lesson we explain to you which properties are of fundamental importance for a market economy, how it is coordinated and which different forms of market economy there are. You can then check your newly acquired knowledge using a few exercise questions.

Why should you know the market economy?

According to psyknowhow, the market economy is the most widespread economic system. It is therefore essential to know and understand their properties, mechanisms and framework of effects. The social market economy is of particular relevance, since it is the economic order of the Federal Republic of Germany.

Characteristics of a market economy

A characteristic of a market economy is the decentralized planning and control of economic processes across the individual markets. The task of coordination is taken over by the price mechanism, i.e. the interplay between supply and demand, the result of which is the price.

Apart from the general conditions set by the state for transactions, the price mechanism takes place without state influence. In addition, the state has the task of providing public goods.

The regulation of competition and environmental policy is also known as regulatory policy. Direct interventions on the part of the state are also possible and are assigned to litigation policy.

Forms of market economy

In practice there are several forms of market economy, the differences between which arise primarily from the handling of the means of production in private ownership.

The following types of market economy are particularly common or of high relevance:

  • Free market economy
  • Social market economy
  • Socialist market economy

In addition, there are other forms of market economy as purely theoretical models. These include:

  • Sustainable market economy
  • Humane market economy
  • Eco-social market economy
  • Ethical market economy
  • Civilized market economy

Free market economy

The free market economy can be described as the most primitive form of the market economy. The decision about which goods and services are offered on the market is made solely by the market based on supply and demand.

market economy

This presupposes that free competition, free choice of occupation and free pricing are possible. However, it should be taken into account that a completely free market economy is only a theoretical model, the prerequisite for which is that the state does not interfere in any way with what is happening on the market. So there should be no taxes, tariffs or legal restrictions (e.g. on drugs and weapons).

Market economy: Free market economy – supply and demand

Free market economy in practice

Although a free market economy has been able to establish itself in many countries, this only exists there in an adapted form with corresponding state regulation. The exact opposite of a free market economy is the planned economy, in which the state alone controls the supply.

Characteristics of the free market economy

  • There is free pricing.
  • Production factors are exclusively in private hands.
  • Income can only be generated through services and profits from private companies.
  • No political or government intervention.
  • Market participants have unlimited freedom of choice when it comes to consumption, career choice, saving and investing.

The state in the free market economy

According to Adam Smith, however, the state does not withdraw completely in a free market economy. It continues to have important tasks such as external security and the protection of citizens from the oppression and unjust behavior of its fellow citizens.

In addition, the state provides public institutions for which no private investor can be found and which it tries to counteract the formation of monopolies.

Social market economy

The basic idea of ​​the social market economy is based on the freedom of the economy and a functioning competition with simultaneous prosperity and social security.

Social market economy – supply & demand and the state

The social market economy is the economic order of the Federal Republic of Germany. Their concept goes back to the reconstruction of the country after the Second World War as an alternative to a state-controlled economy and was largely developed by Alfred Müller-Armack (1901-1978, German economist and cultural sociologist) and Ludwig Erhard (1897-1977, economist and politician, former Chancellor of the Federal Republic of Germany).

At its core, the social market economy is based on the fact that a functioning economic order must be created and maintained by the state. However, it is not a closed system, but rather an open system, which must be checked and improved accordingly in the event of new findings and values.

Characteristics of the social market economy

  • Free pricing
  • Private ownership of the means of production
  • Competition rules and securing of competition
  • Economic and growth policy
  • Goal of full employment
  • Low inflation and stable monetary value
  • Social security, social justice and social progress

Socialist market economy

In contrast to the two previous forms of the market economy, the socialist market economy is characterized by state or community ownership of the means of production.

Exceptions are small businesses, craft businesses and agriculture. The economic process will continue to be coordinated on a decentralized basis, with state structure control taking place via the markets.

A distinction can be made here between the forms “state socialist market economy” and “self-administered socialist market economy”.

Capitalism and market economy

In the literature it happens more often that capitalism and market economy are either sharply demarcated from one another or – quite in contrast to this – both terms are used synonymously.

The existence of a capitalist economic order is usually linked to the premise that private ownership of the means of production is fundamentally possible. In the market economy itself, the focus should only be on satisfying needs via markets.


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