# What Is a Market Economy, and How Does It Work?

> **Definition**
>
> In a market economy, the production and pricing of goods and services are driven by buyers and sellers rather than government control.

## What Is a Market Economy?

A market economy is an economic system in which the production of goods and services is determined by [supply and demand](https://www.investopedia.com/terms/l/law-of-supply-demand.asp). Interactions between consumers and businesses determine what is available and at what price.  

### Key Takeaways

*   In a market economy, the law of supply and demand is allowed to determine levels of production and the prices of goods and services.
*   A market economy gives entrepreneurs the freedom to pursue profits by creating new products, and the freedom to fail if they misread the market.
*   Economists broadly agree that market economies produce better economic outcomes than those controlled by government, but they differ on the precise balance between a free market and central planning.

![Market Economy](https://www.investopedia.com/thmb/jzlLB24HBxDJkFoQwTqubugtAzc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Term-Definitions_Market-economy-Final-v2-2617a685cf7841249347d9cc37b65580.jpg)

*The United States is generally considered a market economy. — Mira Norian / Investopedia*

## How Market Economies Work

Market economies rely on the forces of supply and demand to determine the appropriate prices and quantities for most goods and services.

Entrepreneurs marshal the [factors of production](https://www.investopedia.com/terms/f/factors-production.asp)—land, labor, and capital—and combine them in cooperation with workers and financial backers to produce goods and services for consumers or other businesses to buy.

Buyers and sellers voluntarily agree on the terms of these transactions, including price.

The allocation of resources by entrepreneurs in different businesses and production processes is determined by the consumer [demand](https://www.investopedia.com/terms/d/demand.asp) that they hope to create.

Successful entrepreneurs are rewarded with profits that can be reinvested in future business growth. Unsuccessful entrepreneurs adapt and revise their products, or go out of business.

## Market Economy Example

The United States is an example of a market economy. Its central bank, the [Federal Reserve](https://www.investopedia.com/terms/f/federalreservebank.asp), attempts to maintain a stable economy through its monetary policy and its goals of full employment and low inflation.

In addition, the U.S. [Congress](https://www.investopedia.com/terms/b/bicameral-system.asp) can pass legislation to boost economic activity or protect consumers.

But the main driver of the [economy](https://www.investopedia.com/terms/e/economy.asp) is the force of supply and demand driven by producers and consumers.  

## Market Theory

The theoretical basis for market economies was developed by classical economists such as [Adam Smith](https://www.investopedia.com/updates/adam-smith-economics/), [David Ricardo](https://www.investopedia.com/terms/d/david-ricardo.asp), and [Jean-Baptiste Say](https://www.investopedia.com/terms/j/jean-baptiste-say.asp).

These liberal [free market](https://www.investopedia.com/terms/f/freemarket.asp) advocates believed that the “[invisible hand](https://www.investopedia.com/terms/i/invisiblehand.asp)” of the profit motive and market incentives generally guided economic decisions down more productive and efficient paths than government planning of the economy.

They argued that government intervention often led to economic inefficiencies that made people in general worse off.

## Modern Market Economies

Every economy in the modern world falls somewhere along a continuum from pure market to fully planned. Most developed nations are technically mixed economies because they [blend free markets with some government interference](https://www.investopedia.com/ask/answers/050615/what-are-main-differences-between-mixed-economic-system-and-pure-capitalism.asp).

They are labeled market economies because they allow market forces to drive the vast majority of activities, typically engaging in government intervention only to the extent that it is needed to provide stability.

### Mixed Economies: The Market Economy of Choice

Market economies may engage in some government interventions, such as [price fixing](https://www.investopedia.com/terms/f/fixing.asp), licensing, [quotas](https://www.investopedia.com/terms/q/quota.asp), and industrial subsidies. Most commonly, market economies feature government production of [public goods](https://www.investopedia.com/terms/p/public-good.asp), often as a government monopoly.

But overall, market economies are characterized by decentralized economic decision-making by buyers and sellers transacting everyday business.

In particular, market economies are distinguished by having functional markets for corporate control, which allow for the transfer and reorganization of the economic means of production among entrepreneurs.

### Disagreement Over the Degree of Government Input

Although the market economy is clearly the modern system of choice, there continues to be significant debate regarding the amount of government intervention considered optimal for efficient economic operations.

Most economists believe that market-oriented economies are most successful at generating wealth, economic growth, and rising living standards for a nation.

However, they differ on the precise scope, scale, and specific roles for government intervention that are necessary to provide the fundamental legal and institutional framework that markets need to function well.

## Market Economy Countries

Like the U.S., most countries have primarily market economies. Keep in mind, however, that such economies are still influenced to some degree by government policies.

This may take the form of laws setting minimum wage, subsidies for certain industries or sectors, and policies that prohibit the production and sale of certain products and services due to potential risks to consumers.

Among some of the largest economies in the world, the following are primarily market economies:

*   U.S.
*   Japan
*   Germany
*   United Kingdom
*   Canada
*   Italy
*   Brazil
*   Australia
*   Mexico
*   Spain
*   France

## What Is a Mixed Economy?

Most modern nations considered to be market economies are mixed economies. That is, supply and demand drive the economy. Interactions between consumers and producers are allowed to determine the goods and services offered and their prices.

However, most nations also see the value of a central authority that steps in to prevent malpractice, correct injustices, or provide necessary but unprofitable services. Without government intervention, there can be no worker safety rules, consumer protection laws, emergency relief measures, subsidized medical care, or public transportation systems.

## What Is the Difference Between a Planned Economy and a Market Economy?

In a planned economy, the government controls production, distribution, and prices. It makes all of the economic decisions through a central plan, specifically about how to allocate resources in order to meet collective goals.

A market economy, on the other hand, relies on supply and demand to dictate economic decisions such as the allocation of resources. Competition between market participants determines prices.

Planned economies are focused on stability through state control, which can often lead to inefficiencies. Market economies focus on individual choice, efficiency, and innovation.

## Are Capitalism and a Market Economy the Same Thing?

Capitalism and a market economy both describe a system that allows the law of supply and demand, not a central government, to determine the production and prices of goods and services. [Capitalism](https://www.investopedia.com/terms/c/capitalism.asp), however, is a political philosophy. It maintains that production must remain in private hands and be motivated by the pursuit of private profit.

## Is a Market Economy Good or Bad?

Most economists say that a market economy system is best able to deliver a high quality of life to most citizens. Its benefits include increased efficiency, steady economic growth, and motivation for innovation. Its potential downsides include the risks of monopolies, exploitation of labor, and income inequality.

## The Bottom Line

A market economy is driven by the law of supply and demand. However, most modern economies could be called mixed economies. That is, the government steps in as needed to stabilize the economy, alleviate problems, or correct injustices.

The challenge for economists, and for all citizens, is defining the degree of government intervention that is required.  

> **Article Sources**
>
> 1.  Federal Reserve Bank of St. Louis. “[The Role of Self-Interest and Competition in a Market Economy—The Economic Lowdown Podcast Series](https://www.stlouisfed.org/education/economic-lowdown-podcast-series/episode-3-the-role-of-self-interest-and-competition-in-a-market-economy).”
>     
> 2.  globalEDGE, Michigan State University. “[Get Insights by Country](https://globaledge.msu.edu/global-insights/by/country).”