The term “market economy” describes an economic system in which the exchange of goods takes place mainly in markets.
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Definition / explanation
The individual market participants make their decisions about production and consumption freely and in competition with one another - in an effort to maximize their own benefit.
Durch den Preismechanismus, der die Knappheit der Güter anzeigt, werden supply and demand trotz divergierender Interessen ohne zentrale Steuerung in Übereinstimmung gebracht.
If the demand for a good is greater than the supply, the producers raise the price. The higher profit margin increases the incentive to produce more. At the same time, consumers are reducing their demand.
Conversely, oversupply leads to falling prices. Suppliers are struggling with falling margins and restrict production, while consumers have greater demand for the goods.
Free market economy
The free market economy is the ideal type of a pure market economy without state intervention in economic activity. All means of production are private. The economic role of the state lies solely in guaranteeing freedom of contract and property rights.
A free market economy corresponds to the liberal understanding of the enlightened and responsible citizen. It works without compulsion and guarantees the free development of the individual. Through contest und effiziente Allocation der Ressourcen generiert sie Wohlstand und Innovation.
However, the market creates an unequal distribution of income and wealth, which in turn leads to unequal starting opportunities for the individual. From a certain point onwards, society perceives this to be unfair. Furthermore, disadvantaged people are often unable to earn a living income on the market.
There are also cases in which markets do not manage to allocate resources optimally:
Some market transactions have negative (or positive) effects (externalities) on uninvolved third parties that are not compensated for by the market price.
Public goods such as air or the legal system cannot be allocated to individual owners, nor are they scarce. Therefore, they cannot be traded on the market.
Markets are often unstable in the short and medium term and cause business cycles.
Social market economy
A sense of social justice and market failure are the main reasons why the market economy has so far always and everywhere been combined with a certain level of government intervention.
Where the markets create a problem that is supposed to be cured by state intervention, there are different judgments depending on the ideological position. In addition, government intervention can also have undesirable side effects known as government failure.
Germany is based on the model of the social market economy coined by Alfred Müller-Armack and Ludwig Erhard. This form of market economy relies on the free play of supply and demand for the efficient supply of goods.
The state tries, however, to prevent one-sided concentration of power in the market. To this end, it intervenes in the various markets such as the financial, labor or housing market and operates an active competition policy. Through progressive taxation and social transfers (see State transfers) it creates a balance between the social classes and cushions emergencies with social insurance.