THE FUNCTION AND NATURE OF MARKETS
IN A FREE MARKET, THE PRICE AND QUANTITY OF AN ITEM ARE
DETERMINED BY THE SUPPLY AND DEMAND FOR THAT ITEM.
LEARNING OBJECTIVE
SUMMARIZE THE DEFINING CHARACTERISTICS OF A FREE MARKET
ECONOMY
KEY POINTS
• A MARKET IS DEFINED AS A SYSTEM OR INSTITUTION WHEREBY
PARTIES ENGAGE IN EXCHANGE. A MARKET ECONOMY IS AN
ECONOMY IN WHICH DECISIONS REGARDING INVESTMENT,
PRODUCTION, AND DISTRIBUTION ARE BASED ON SUPPLY AND
DEMAND, AND PRICES OF GOODS AND SERVICES ARE DETERMINED IN
A FREE PRICE SYSTEM.
• IN A PERFECTLY COMPETITIVE MARKET THERE ARE MANY BUYERS
AND SELLERS SO NO INDIVIDUAL ACTOR MAY AFFECT A GOOD'S
PRICE; THERE ARE NO BARRIERS TO EXIT OR ENTRY; PRODUCTS ARE
HOMOGENEOUS; AND ALL ACTORS IN THE ECONOMY HAVE PERFECT
INFORMATION.
• CHANGES TO THE MARKET SUPPLY AND MARKET DEMAND WILL
CAUSE CHANGES IN THE EQUILIBRIUM PRICE AND QUANTITY OF THE
GOOD PRODUCED.
, • WHEN MARKETS ARE PERFECTLY COMPETITIVE, THE EQUILIBRIUM
OUTCOME OF TRADE IN THE MARKET IS ECONOMICALLY EFFICIENT.
THIS MEANS THAT THE MARKET IS PRODUCING THE LARGEST NET
GAIN POSSIBLE FOR SOCIETY, GIVEN CONSUMERS' UTILITY
FUNCTIONS AND PRODUCERS' PRODUCTION FUNCTIONS.
KEY TERMS
EQUILIBRIUM
THE CONDITION OF A SYSTEM IN WHICH COMPETING INFLUENCES ARE
BALANCED, RESULTING IN NO NET CHANGE.
MARKET ECONOMY
AN ECONOMY IN WHICH GOODS AND SERVICES ARE EXCHANGED IN A FREE
MARKET, AS OPPOSED TO A STATE-CONTROLLED OR SOCIALIST ECONOMY;
A CAPITALISTIC ECONOMY.
IN ECONOMICS, A MARKET IS DEFINED AS A SYSTEM OR INSTITUTION
WHEREBY PARTIES ENGAGE IN EXCHANGE. A MARKET ECONOMY IS AN
ECONOMY IN WHICH DECISIONS REGARDING INVESTMENT, PRODUCTION,
AND DISTRIBUTION ARE BASED ON SUPPLY AND DEMAND, AND PRICES OF
GOODS AND SERVICES ARE DETERMINED IN A FREE PRICE SYSTEM. THE
MAJOR DEFINING CHARACTERISTIC OF A MARKET ECONOMY IS THAT
DECISIONS ON INVESTMENT AND THE ALLOCATION OF PRODUCER GOODS
ARE MAINLY MADE THROUGH MARKETS. THIS IS THE OPPOSITE OF A
PLANNED ECONOMY, WHERE INVESTMENT AND PRODUCTION DECISIONS
ARE EMBODIED IN A PLAN OF PRODUCTION.
2
IN A FREE MARKET, THE PRICE AND QUANTITY OF AN ITEM ARE
DETERMINED BY THE SUPPLY AND DEMAND FOR THAT ITEM.
LEARNING OBJECTIVE
SUMMARIZE THE DEFINING CHARACTERISTICS OF A FREE MARKET
ECONOMY
KEY POINTS
• A MARKET IS DEFINED AS A SYSTEM OR INSTITUTION WHEREBY
PARTIES ENGAGE IN EXCHANGE. A MARKET ECONOMY IS AN
ECONOMY IN WHICH DECISIONS REGARDING INVESTMENT,
PRODUCTION, AND DISTRIBUTION ARE BASED ON SUPPLY AND
DEMAND, AND PRICES OF GOODS AND SERVICES ARE DETERMINED IN
A FREE PRICE SYSTEM.
• IN A PERFECTLY COMPETITIVE MARKET THERE ARE MANY BUYERS
AND SELLERS SO NO INDIVIDUAL ACTOR MAY AFFECT A GOOD'S
PRICE; THERE ARE NO BARRIERS TO EXIT OR ENTRY; PRODUCTS ARE
HOMOGENEOUS; AND ALL ACTORS IN THE ECONOMY HAVE PERFECT
INFORMATION.
• CHANGES TO THE MARKET SUPPLY AND MARKET DEMAND WILL
CAUSE CHANGES IN THE EQUILIBRIUM PRICE AND QUANTITY OF THE
GOOD PRODUCED.
, • WHEN MARKETS ARE PERFECTLY COMPETITIVE, THE EQUILIBRIUM
OUTCOME OF TRADE IN THE MARKET IS ECONOMICALLY EFFICIENT.
THIS MEANS THAT THE MARKET IS PRODUCING THE LARGEST NET
GAIN POSSIBLE FOR SOCIETY, GIVEN CONSUMERS' UTILITY
FUNCTIONS AND PRODUCERS' PRODUCTION FUNCTIONS.
KEY TERMS
EQUILIBRIUM
THE CONDITION OF A SYSTEM IN WHICH COMPETING INFLUENCES ARE
BALANCED, RESULTING IN NO NET CHANGE.
MARKET ECONOMY
AN ECONOMY IN WHICH GOODS AND SERVICES ARE EXCHANGED IN A FREE
MARKET, AS OPPOSED TO A STATE-CONTROLLED OR SOCIALIST ECONOMY;
A CAPITALISTIC ECONOMY.
IN ECONOMICS, A MARKET IS DEFINED AS A SYSTEM OR INSTITUTION
WHEREBY PARTIES ENGAGE IN EXCHANGE. A MARKET ECONOMY IS AN
ECONOMY IN WHICH DECISIONS REGARDING INVESTMENT, PRODUCTION,
AND DISTRIBUTION ARE BASED ON SUPPLY AND DEMAND, AND PRICES OF
GOODS AND SERVICES ARE DETERMINED IN A FREE PRICE SYSTEM. THE
MAJOR DEFINING CHARACTERISTIC OF A MARKET ECONOMY IS THAT
DECISIONS ON INVESTMENT AND THE ALLOCATION OF PRODUCER GOODS
ARE MAINLY MADE THROUGH MARKETS. THIS IS THE OPPOSITE OF A
PLANNED ECONOMY, WHERE INVESTMENT AND PRODUCTION DECISIONS
ARE EMBODIED IN A PLAN OF PRODUCTION.
2
