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The advantage of market economy

Capital flows to where it will get the greatest return, expanding the total size of the economy to its
maximum level.

2) Supply and demand are closely linked: Someone who has a good idea or product can quickly put it into
the market so that it is available to those who want it. Conversely, when a certain type of product is
desired by enough people, it is a simple matter for someone to provide it.

3) In a market economy, it is easier for someone with initiative and virtue to create a better life for
themself and their family; economic freedom makes it eaiser to transform hard work and perseverance
into material wealth.

Definition of 'Market Economy'


An economic system in which economic decisions and the pricing of goods and services are guided
solely by the aggregate interactions of a country's citizens and businesses and there is little government
intervention or central planning. This is the opposite of a centrally planned economy, in which government
decisions drive most aspects of a country's economic activity.



Investopedia Says
Investopedia explains 'Market Economy'


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Market economies work on the assumption that market forces, such as supply and demand, are the best
determinants of what is right for a nation's well-being. These economies rarely engage in government
interventions such as price fixing, license quotas and industry subsidizations.

While most developed nations today could be classified as having mixed economies, they are often said
to have market economies because they allow market forces to drive most of their activities, typically
engaging in government intervention only to the extent that it is needed to provide stability. Although the
market economy is clearly the system of choice in today's global marketplace, there is significant debate
regarding the amount of government intervention considered optimal for efficient economic operations.





















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Market economy
An economy in which scarce resources are all (or nearly all) allocated by the interplay of supply and
demand in free markets, largely unhampered by government rationing, price-fixing or other coercive
interference. In classifying real historical economies, the level of "marketization" is not primarily an
either/or issue but rather a matter of degree. The greater the proportion of the goods and services
produced in the society that are allocated by market processes (rather than by government edict or the
operation of unchangeable custom), the more meaningful it is to refer to its economy as a market
economy -- and the more useful is the abstract economic theory of the operation of markets likely to be
for understanding and even predicting economic behavior within that society.
Probably the most critical single distinction between "basically market" and "basically non-market"
(socialist, feudal, hunter-gatherer, etc.) economies is whether or not the determinations of what is to be
produced and of the corresponding allocation of producers' goods (land, raw materials, machinery, and
other "capital," as well as the services of labor) are accomplished primarily through free markets rather
than primarily through government command or unalterable custom.
The concept of a market presupposes the existence of certain sorts of property relations in the society
involved. At least some goods and services must be legally or socially regarded as alienable property --
that is, there must be ascertainable individuals (or group representatives) who are recognized as having
not just the right to use particular scarce economic resources for their own purposes but also the
discretionary authority permanently to transfer such rights of use to someone else in exchange for some
mutually agreeable quid pro quo, such as money or other goods or services. Not all human societies have
recognized any such rights to transfer ownership, and most historical human societies have forbidden or
placed stringent limits on the transferability of at least certain kinds of recognized property rights. In many
societies (including most of Europe during the Middle Ages), individual or family rights to the perpetual
use of particular plots of land were well established and protected by law -- but such rights only rarely
could legally be sold to someone else because the land was socially regarded as fundamentally the
inalienable property of either the local community as a whole or of the tribe or clan or church or perhaps
of the reigning royal family. And even in the USA since 1865, while each person's ownership of his or her
own body is well established, the law will still not allow you to make a binding contract to sell yourself into
slavery or even to auction off your spare bodily organs for purposes of a surgical transplant.)
It is worth noting for clarity's sake that the concept of a market does not logically presuppose the
existence of "private property in the means of production" in the sense that private individuals or family
households are the owners of land and capital and thus the recipients of profits, interest, rent etc. One
may at least theoretically conceive of an economy of market socialism, in which workers' collectives,
consumers' cooperatives, village communes or even autonomous state agencies leased from the state or
held actual title to land, mines, factories, machinery and so forth -- so long as the socialist production
organizations were free to buy and sell their output and and the use of their assigned land or capital
assets to each other at freely negotiated prices responsive to conditions of supply and demand
(assuming, of course, they are allowed to keep effective control of the bulk of the proceeds). There are, of
course, both theoretical and practical problems with market socialism, and the costs and benefits of
capitalist markets cannot be uncritically attributed to such a system. The larger point is that socialist
economies have historically included varying proportions of "remnant" market elements in their make-up,
and the theoretical possibilities for additional "hybrid" forms are numerous.

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Growth theory
The part of economic theory that seeks to explain (and hopes to predict) the rate at which a country's
economy will grow over time. Economic growth is usually measured as the annual percentage rate of
growth in one or another of the country's major national income accounting aggregates, such as Gross
National Product or Gross Domestic Product (almost always with appropriate statistical adjustments to
discount the potentially misleading effects of price inflation). Just about any country's economy will show
sizable year-to-year and quarter-to-quarter fluctuations in its economic growth rate, but economic growth
theorists tend to concentrate their efforts on analyzing and explaining the smaller variations in the longer-
term trend or average rate of economic growth over periods of a decade or more. They leave explanation
of the shorter-term fluctuations around the longer-term trend to specialists in business cycle theory
because investigation has shown that the predominant influences on short-term growth rates seem to
differ in important ways from the determinants of an economy's long term average growth performance. It
might also be added that the political effects of variations in long range economic growth rates tend to be
substantially different from the political effects of the booms and busts of the business cycle.

The short term ups and downs of the business cycle have dramatic effects on popular perceptions of the
country's economic well-being. In a recession, hundreds of thousands or even millions of people may
become unemployed and suffer dramatic declines in their incomes for the duration of the crisis -- usually
for a period of somewhere between six months and one-and-a-half years before more normal economic
conditions return again. Yet over the long haul, even rather small increases or decreases in the trend rate
of economic growth will have much more profound and enduring effects on economic production and
hence on the material living standards of the population. As an illustration, consider the following: During
the period since the end of World War II (1946 to 1999-I), the growth rate of GDP for the United States
(corrected for inflation) has averaged about 3.3% per year. Assuming that the typical undergraduate
student reading this text was born in 1979, the growth rate of the US economy over his or her lifetime has
averaged a slightly lower 2.7% per year - a difference of "only" 0.6 percentage points per year. But if the
US had been able to maintain the same average growth rate from 1979 to 1999 that it had enjoyed during
1946 to 1978 (about 3.6%), 1998 GDP would have reached 9.152 trillion 1992 dollars worth of goods and
services instead of the 7.552 trillion dollars of production actually achieved. That means that the income
of the average American household in 1998 (and every single year thereafter) could have been more than
20% higher than it actually turned out to be if only a way could have been found to prevent this seemingly
slight decline in the trend rate of economic growth. And if the US economy had somehow managed to
average the slightly higher growth rate of an even 4% for the whole postwar period, the income of the
average American household from 1998 on could have been about half again as much over what was
(and will later be) at their disposal.

Explaining differences between countries in their long term economic growth rates is a complex matter,
and the scientific literature on the subject is filled with controversies both technical and ideological in
nature. Many of the theoretical determinants of long term growth rates are difficult to measure very
adequately and many of the least imperfect measurements available for testing the various theories have
been systematically collected in much of the world only for a relatively recent historical period -- roughly
the last 20 to 30 years. Nevertheless one eminent scholar's recent survey of the published professional
literature came up with over sixty different variables that have been put forward by theorists as enhancing
or retarding long term economic growth and that also actually showed significant evidence of real
explanatory power in one or more systematic statistical tests using a broad range of 20th century
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historical data. There is broad support in virtually all empirical studies for a strong positive impact on
economic growth by the investment rate (especially the rate of investment in plant and equipment) and by
various measures of human capital (such as the literacy rate, school enrollment ratios, and average life
expectancy). Although it is difficult to measure separately from investment and improvement of human
capital, there is also substantial support for the positive contribution of continuing technological innovation
and improvement in sustaining the process of economic growth by improving productivity. A majority of
the other variables that have been brought into economic growth theory are conceived of as influencing
growth rates mainly in an indirect fashion by affecting either the volume or the efficiency in utilization of
investment and/or of human capital and/or technological progress. There is also substantial and robust
support in the empirical literature for the hypothesis of "conditional convergence" - that is, because of
diminishing returns to capital, the lower a country's level of real GDP per capital at the beginning of a
given historical period, the faster the country's subsequent growth rate tends to be (an initial advantage of
less developed countries that in practice has been all too often offset by counterproductive governmental
policies and by disruptive conditions such as frequent coups, lawlessness, warfare and civil strife that
tend to retard savings and investment rates and to destroy or drive out a lot of human capital).

Various kinds of public policy variables also seem to make a difference in growth rates. Countries with
relatively "open" economies (that is, those which allow relatively free movement of goods and capital in
and out of the country without high tariffs, protectionist import quotas, foreign exchange controls or major
restrictions on foreign investment) have tended to maintain higher growth rates than countries with more
restrictive policies. Countries that allow extremely rapid expansion of their money stocks and thus bring
on high rates of inflation (about 20% per year seems to be a critical threshold) have tended to experience
sharply lower economic growth rates than countries with low or moderate rates of inflation. Countries
whose legal systems provide relatively reliable enforcement of private contracts and relatively secure
protection for private property rights have tended to grow more rapidly than countries whose legal
systems are bogged down by corruption, arbitrary judicial decision-making, frequent radical changes in
basic legal principles, ex post facto legislation and/or just plain lack of prompt and effective enforcement
of the law.

Some of the most emotion-laden and ideologically-tinged debates on economic growth theory deal with
two questions on which no broad consensus seems likely in the near future: What sort of mixture of
government planning and control versus the free market is most conducive to economic growth? And
what are the effects of different cultures (especially differences in religious and ethical values) on
promoting or retarding economic growth?

Taking the second question first, it should be noted that many of the earliest theories about what causes
economic growth were largely cultural in nature. Adam Smith, David Ricardo, Thomas Malthus and many
others (even Karl Marx) laid great stress on the importance to economic growth of such culturally
conditioned values or attitudes as thrift, the value of diligence and hard work, ambition for a better
material standard of living, respect for other people's property rights, the sense of obligation to honor
agreements and contracts, inventiveness, willingness to adopt new ways of doing things and so on. Many
of these values are fostered and reinforced (or possibly denigrated and condemned) in different measure
within different cultural traditions, and an especially important role in this is played by organized religion. It
is not surprising then that nowadays we still see a lot of more or less informed speculation about the role
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of this religion or that in fostering or inhibiting economic growth, especially in less developed regions of
the world. (Max Weber's classic essay on "The Protestant Ethic and the Spirit of Capitalism" is one of the
best known and most closely reasoned classic examples of this tradition in the social sciences.) Two or
three decades ago, the prevalence of Roman Catholicism in southern Europe and Latin America and its
alleged anti-commercial social and economic values were often invoked as a part of the explanation for
the relative economic backwardness of these regions compared to mainly Protestant northern Europe
and North America. In much more recent times, the influence of Islam in fostering fatalistic attitudes and
anti-commercial or anti-materialist values (such as the condemnation of all lending at interest) is often
invoked as part of the explanation for the relative economic backwardness of the Moslem countries,
despite the huge advantages many of them enjoy in the form of rich endowments of natural resources like
petroleum. The conservative anti-materialist and fatalistic elements of Hinduism are often put forward as
an explanation for India's backwardness. Weber believed that Confucianism greatly hindered China's
economic development over the centuries, but ironically the same Confucian heritage is today more often
invoked as an explanation for the rapid commercial development of such places as Hong Kong, Taiwan,
and Singapore. The problem with such explanations is that all major religious traditions contain some
elements that can encourage economic activity along with other elements that inhibit it, and determining
which influences will predominate in any particular place and time is a game that tends to be played with
far too many wild cards, with the theorist opportunistically seizing upon whichever elements of the local
religious tradition best seem to fit with what he already knows has been happening lately. It is hard to
deny that cultural values matter for economic development and that religion plays an important role in
fostering the people's values, but correlating changes in people's values with changes in economic growth
performance requires much better measurement than is possible by simplistic references to which
particular religious faith has predominated in the particular country for centuries. A more promising
approach is for researchers to go out periodically and directly sample the distributions of particular "pro-
growth" and "anti-growth "attitudes among the populations of various countries (perhaps by survey
research polling methods) rather than simply assuming the presence of these values and attitudes on the
basis of formal religious doctrines. Only then does it make sense to begin gingerly pronouncing upon how
the prevalence or lack of particular values correlate with actual long-term economic growth performance
in subsequent years.

As to the first question, socialist and communist economists used to argue that a totally government
controlled and planned economy would enjoy more rapid economic growth than a capitalist economy,
primarily basing their case on the idea that a planned economy would maintain a steadier and higher rate
of investment, free of the periodic slowdowns of investment caused by periodic financial crises in the
capitalist business cycle. It was also assumed that a more egalitarian socialist educational policy would
be much more successful in promoting widespread education for the masses, greatly enhancing the
supply of what we would today call human capital. Economists more favorably inclined toward the free
market system acknowledged that the total amount of investment in both non-human and human capital
was indeed very important to rapid economic growth but cautioned that the efficiency with which these
resources were allocated was also of extreme importance. A capitalist economy , they argued, has a
much better system of incentives for encouraging the most efficient allocation of economic resources,
whereas the socialist economy would tend to get bogged down in bureaucratic waste and misallocation of
resources that would lead to even more waste than the "anarchy of the market."

It is now reasonably clear from the historical record of the last thirty years or so that the closer to capitalist
the economy has been, other things being equal, the more successful it has been in achieving higher long
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term rates of economic growth. During that same period, countries at the extreme socialist end of the
scale, especially the countries of the Communist bloc and their third world client states, have seen their
initially fairly high rates of economic growth dwindle away gradually to zero and then plunged rapidly into
full-scale economic collapse in the late 1980s. Since then, only those relatively few former Communist
countries that moved most rapidly and radically to adopt capitalistic institutions and practices have
resumed respectable rates of economic growth (such as Poland, Hungary, the Czech Republic, Estonia),
while the vast majority of them have stagnated for about a decade in a kind of Never-never land where
government bureaucrats have largely lost their power to plan, finance and administer state-owned
enterprises but most of the legislation necessary to legalize and unleash private business still remain on
hold. Many of the non-Communist countries of the world that formerly had relatively large public sectors
and extensive government controls over the economy have enacted reforms to privatize some of their
state-owned enterprises and to open up their economies to more foreign trade and outside investment -
and most (but not all) of them have since experienced at least modest improvements in their economic
growth rates (although it is still too soon to tell whether these improvements represent changes in the
long term trend or only temporary cyclical upswings).

Clearly the advocates of the free market have been scoring a lot of points in the debates over the past
decade or two and have won over some of the skeptics, but their remaining opponents have by no means
lost all of their intellectual ammunition. Die-hard advocates of full-scale socialism can (and do) still argue
that socialism has not failed economically because "true" socialism has never been fully implemented (the
Soviets and their former comrades in Eastern Europe and the Far East went ideologically wrong
somewhere in the beginning) - and if it were really to be tried in the future , surely it would painlessly
combine social justice, perfect democracy and the most rapid possible economic progress. Less fanciful
socialists can argue that there have actually been at least a few relatively successful growth stories in
countries that retain many of the trappings of old fashioned state socialism (mainland China being the
most telling example, since about one-third of the human species lives and works there). Some elements
of the political left (including the economists among them) reluctantly accept the idea that more
government control of the economy might lead to somewhat slower economic growth but then go on to
say that low (or no) growth in GDP would be worth it if it was required in order to promote greater social
justice. Still others on the left, especially the "Greens," believe that an end to economic growth would be a
positive good because people should reject excessively materialistic consumerist values and because it
seems to them to be necessary in order to save the planet from environmental catastrophe. More
conventional moderate socialists and social democrats more often take the line that they now accept the
importance of retaining many elements of the market economy but still insist that a "middle way" with
considerably larger amounts of government ownership, regulation and control than now exist in the
United States or much of Western Europe could maintain or even improve upon present economic growth
rates if done carefully and in the right way. Only a few of these arguments are susceptible to proof or
disproof by reference to numbers in the historical record since they contain value judgments as well as
empirical assumptions. And it must be acknowledged that the limited amount of data we have amassed
over just the past few decades is still a very long way from what one would like to have for decisively
resolving even the more tractable empirical disputes over just how economic growth rates get
determined.



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Gross domestic product (GDP) is the market value of all officially recognized final goods and services
produced within a country in a year, or other given period of time. GDP per capita is often considered an
indicator of a country's standard of living.[2][3]

GDP per capita is not a measure of personal income (See Standard of living and GDP). Under economic
theory, GDP per capita exactly equals the gross domestic income (GDI) per capita (See Gross domestic
income).

GDP is related to national accounts, a subject in macroeconomics. GDP is not to be confused with gross
national product (GNP) which allocates production based on ownership.


Macroeconomics is the study of the aggregate performance of the economy. The unemployment rate,
which measures the ratio of the number of people unsuccessfully looking for work to the total labor force,
is one important indicator. Another key macroeconomic indicator is the the rate of inflation, which you will
recall is the average rate of change of the prices for all goods and services.

2. The theory of economic growth, which we covered as our first major topic in this course, explains the
growth of potential output, assuming that the economy's resources are fully utilized. However, economies
have spent long periods of time operating below potential, giving rise to the issues of macroeconomics.

Although the Great Depression of the 1930's was not the first business cycle downturn, it was dramatic in
terms of its severity, particularly in contrast with the prosperity of the previous decade. In the middle of
this crisis, British economist John Maynard Keynes created a new theoretical framework that became the
basis for what we teach as macroeconomics. Prior to Keynes, what theories there were about
unemployment offered little guidance for how to cure it. Keynes showed how the government can use
budget policy and monetary policy to prevent the sort of long, severe slump that occurred in the 1930's.

Macroeconomics is filled with controversy. There are intelligent, well-trained economists whose beliefs
about macro are diametrically opposed to those of other intelligent, well-trained economists. This poses a
dilemma for a teacher. Do I try to give equal time to all points of view, or do I focus on what I believe? In
these lecture notes, I adopt the latter approach. When you take macroeconomics in college, you can gain
more exposure to the various doctrinal disputes that arose in the past and that still persist.



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Macroeconomic problems arise when the macroeconomy does not satisfactorily achieve the goals of full
employment, stability, and economic growth. Unemployment results when the goal of full employment
is not achieved. Inflation exists when the economy falls short of the stability goal. These problems are
caused by too little or too much demand for gross production. Unemployment results from too little
demand and inflation emerges with too much demand. Stagnant growth means the economy is not
adequately attaining the economic growth goal. Each of these situations is problematic because society
is less well off than it would be by reaching the goals.
Unemployment
Unemployment arises when factors of production that are willing and able to produce goods and
services are not actively engaged in production. Unemployment means the economy is not attaining the
macroeconomic goal of full employment.
While attention is usually focused on the unemployment of labor, such as the time Pollyanna
Pumpernickel was laid off from her job at the OmniMotors Car Company, any of the four factors of
production can suffer unemployment. For example, The Wacky Willy Company might be operating one
of its Stuffed Amigos factories at half capacity or Herb Haberstone might leave a section of his farmland
uncultivated.

Unemployment is a problem because:
Less output is produced and thus the economy is less able to address the scarcity problem.

The owners of unemployed resources receive less income and thus have lower living standards.

Inflation
Inflation arises when the average price level in the economy consistently and persistently increases. In
other words, prices generally rise from month to month and year to year. With inflation the economy is
not attaining the stability goal.
Inflation is an average increase in prices, with some prices rising more than the average, some rising
less, and some even declining. As such, not every member of society is likely to experience exactly the
same inflation.

Inflation is a problem because:
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The purchasing power of financial assets such as money declines, which reduces financial wealth and
lowers living standards.

Greater uncertainty surrounds long-run planning, especially the purchase of durable goods and capital
goods.

Income and wealth can be haphazardly redistributed among sectors of the economy and among
resource owners.

The Business Cycle
Unemployment and inflation tend to vary with business-cycle instability. At some times, unemployment
is less of a problem and inflation is more. At other times, unemployment is more of a problem and
inflation is less. Consider how these two problems connect to the two primary phases of the business
cycle.Contraction: The contraction phase of a business cycle is characterized by a general decline in
economic activity. Aggregate demand is less, meaning less output is produced, and thus fewer resources
are employed. For this reason, unemployment tends to be a key problem. However, because markets
are more likely to have surpluses than shortages, inflation tends to be less of a problem.

Expansion: The expansion phase of a business cycle is characterized by a general rise in economic
activity. Aggregate demand is higher, production is greater, and more resources are employed. Demand
for production often outpaces the ability to supply the production. Under these circumstances, because
markets are more likely to have shortages than surpluses, inflation tends to be the primary problem.
However, with robust production and jobs aplenty, unemployment tends to be less of a problem.

Stagnant Growth
The third problem of stagnant growth arises because the supply of aggregate production is not
increasing at a desired pace or is even declining. An increase in the total production of goods and
services is generally needed to keep pace with an increase in the population of society and expectations
of a rising living standard. Stagnant growth exists if total production does not keep pace. This means the
macroeconomic goal of economic growth is not attained.
Reasons for stagnant growth can be identified with a closer look at the quantity and quality of the
resources used for production.
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Quantity: The available quantities of the four factors of production--labor, capital, land, and
entrepreneurship--can restrict the growth of production.
The quantity of labor is based on both the overall population and the portion of the population willing
and able to work. Should either decline, then growth is not likely to keep pace with expectations. If, for
example, Edgar Millbottom decides to quit his job and spend his time doing nothing but vegetating on
his parents living room sofa, then the total quantity of labor declines.

The quantity of capital depends on the amount of investment expenditures relative to the depreciation
of the existing capital stock. If investment expenditures should decline or depreciation increase, then
the economy is less likely to grow. If, for example, restrictive government regulations and high taxes
discourage The Wacky Willy Company and similar manufacturing companies from building new
factories, then the total quantity of capital declines.


Quality: The quality of the four resources can also lead to stagnant growth. The two most noted
resource quality influences are technology and education. The lack of technological progress, which
could result from allocating fewer resources to scientific research can limit increases in the quantity of
resources. Along a similar line of reasoning, allocating fewer resources to education can also limit
resource quality.