Market Economy refers to an economic system where economic decisions and prices of goods and services are led by the interactions of the businesses and citizens. In other words, it is a system where the production of goods and services change according to the desires and abilities of the businesses and citizens.
The term refers to an economy where the market is the main focus. Government intervention or central planning is minimum. The basic principle of this kind of economy shows that manufacturers and sellers of goods and services will offer the highest price.
Theory for the market economy was coined by classical Economics Adam Smith. Jean-Baptise Say and David Ricardo. These liberal free-market advocates believed in the invisible hand of the profit motive market. They believed that incentives are really helpful for productivity in the market than government planning of the economy. One of the main aspects of their belief of the market economy is that government intervention intended to take the economic efficiencies into another level which actually was unproductive and made consumers experience discomfort.
According to the theory, the economy works using the forces of demand and supply to determine the right prices and quantities for majority goods and services in an economy. Businesses determine Factors of Production like Land labour and Capital and combine them with employees and financial backers to produce goods and services for consumers and other businesses to purchase.
Both buyers and sellers come to an agreement on the terms of these transactions solely based on consumer preferences for goods and services. This also includes the revenues by businesses or revenue they want to earn on their investments.
The resource allocation is decided by businesspersons across their businesses and the process of production with the hopes of making profits by producing output customers value and enjoy. Businesses expect that this should be more than what they have paid for the inputs. It’s also believed that if a business is successful in doing so, they are rewarded with profits that can be reinvested in future businesses. However, if businesses Fail to do so they can learn to do better in the future or opt-out of their business altogether.