Concept of the Market Economy

The Market Economy is an economic system in which the decisions regarding production, investment, and distribution are guided by the price signals which are created by the forces of supply and demand. An economic system is the composition of all the individuals, firms, households, factories, banks, and governments that act and interact with each other for the production and consumption of goods and services.

The market mechanism or the price mechanism is the process where the market economy functions through the market forces of supply and demand. They are the two forces that interact to determine the price of goods and services.

Let us assume that there are only two kinds of economic units i.e households and business firms. They act and interact with each other for carrying out economic transactions. These economic units interact in two different areas of it and they are:

• sale and purchase of productive resources
• sale and purchase of final goods

These kinds of interactions make the commodity market and factor market. The two economic units continue to interact with each other and then make the market economy. Thus, the market economy is the interaction of two different economic units.

Circular Flow

 The circular flow is the continual flow of money and goods in the economy. In other words, it is the flow of economic activities that shows where the money goes and what it is exchanged for. The circular flow diagram is shown below:-

There are three types of economic systems:-

1. Free Enterprise Economy
2. Government- controlled or command Economy
3. Mixed Economy

All types of economies face certain problems whatever be the nature of the economic system. The economic problem arises from unlimited wants and limited resources. The economic problem gives rise to the following basic problems in an economy:-

1. What to produce?
2. How to produce?
3. For whom to produce?