From the characteristics and different market situations mentioned above, it is quite clear that the market economic system has some advantages over the other two economic systems. But it is even clearer that it has its disadvantages when compared to the other two economic systems. In some cases, these disadvantages can be overlooked but doing this ultimately leads to market failure in the long run. But before the disadvantages can seem clear, the advantages of the market economic system must first be examined.
Presence of competition- First and foremost, there is serious competition amongst producers. The presence of competition is what the market economic system strives on. Why this is so is because private individuals allocate resources in this economy. Now the only reason why a private individual would want to get involved in resource allocation is so as to make profit from utilizing these resources. Under normal circumstances, a producer can only make profit when his product is doing well in the market. The producer's product can only do well in the market if consumers prefer to buy his product rather than its homogenous competitors. Now to ensure that the producer is able to attract consumers, they have to go the extra mile to convince consumers that their product is better than their competitors. This can result in companies generating new techniques and innovations so as to capture their target market. Since all companies in a particular industry are vying to attract and satisfy the same consumers, a lot of firms focus on quality of the product rather than quantity because of the competitive nature of the market.
Consumer & producer sovereignty- As mentioned earlier, the producer's motive in this system is to make profit by satisfying consumers. This therefore gives consumers the freedom to purchase whatever good they wish to purchase because it is believed -in this system- that the forces of demand and supply are the best ways to determine what is best for the nation- even in the case of cigarettes. Although, the consumers have the freedom to purchase whatever good they wish to purchase, they are not the only ones who enjoy this freedom. The producers have just as much freedom as consumers to produce whatever they wish to produce since the resources they are allocating belong to them.
Political freedom- Milton Friedman- an American economist, statistician, and author - stated that the economic freedom of capitalism is a requisite of political freedom. This simply means that if a country wants to get the best out of this system, government intervention must be very minimal in terms of setting boundaries on what to produce and how much to produce. Once this is done, producers have the license and power to express themselves due to this freedom. However, this seems to be the only advantage the government would not want producers to make use of because it has a tendency of diminishing the power of political leaders.
Cost-effective resource allocation- According to Adam Smith, he concluded that the 'invisible hand of the market' is responsible for resource allocation in a market system. Capitalism ensures that resources are allocated according to consumer choice. No firm is rewarded for producing goods that people don't desire so once a product is not doing well in the market, the resources used to make that product are quickly re-allocated.
Economic growth- Although it seems hard to believe, the capitalist economic system actually stimulates economic growth when measured by G.D.P, resource utilization or standard of living. Adam smith suggested that a free market should control production, price and resource allocation because it will stimulate economic growth. It seemed outrageous at the time but statistics show that the increase in global G.D.P overtime is as a result of countries using the modern-day capitalist system. For example:
Now according to the graph above, China did not start employing of the market economic system until 1980. At this point in time their G.D.P- although one of the highest in the world -was far below the 2000 mark. As soon as this system was brought in, a steep increase in the G.D.P commenced. By 2005 China's G.D.P boasted a huge 18232.1 billion (8.859 trillion dollars) which was the highest G.D.P in the world at the time.
Everything that has its advantages must have its disadvantages and the market economic system is no different. Yes, the market economic system will guarantee economic growth, healthy competition and consumer sovereignty. But what are the side effects? Why do governments think twice before implementing such a system? Why can't it be considered the "perfect" economic system since it allocates resources cost effectively? The next few paragraphs would answer that.
Social inequality- The common capitalist saying that says "anyone can be rich if they work hard enough" is a fallacy. There's only so much room at the top. In order to make money, first you have to take it from someone else. This can be done through selling things, taxation or any other means. But this means that the rich cannot exist without the poor. Any way you look at it, there's never going to be equality under capitalism.
Consumer & worker exploitation- This is one of the most controversial topics of discussion when attempting to employ the market economic system. Consumers are very liable to be exploited most likely due to the asymmetric information producers possess about the products they produce. A huge gap between the rich and the poor beckons because it is possible that the rich would take advantage of the economy and its resources when in reality, they merely own the means of production. While workers are paid minimum wage, they don't have any say in how the economy is controlled.
War- According to Top 10 Disadvantages to Capitalism "Many of the wars fought in recent years have been over profit. In Iraq, the war was largely funded by oil barons, and it was private firms who handled most of the security after the initial invasion. In Libya, western forces intervened when the civil war caused oil supplies to be cut off. They only sided with the rebels because they thought they were the most likely to win. In Iran, military intervention is being threatened over the blocking of trading routes to transport oil." (N.D) {Online} Available at: http://listverse.com/2012/01/16/top-10-disadvantages-to-capitalism/ {Accessed 18/10/2012}
Waste- In the market economic system, economic resources are never distributed equally. So there would always be a case when the "wealthy" have an excess amount of resources at their disposal. These resources are actually donated to the poor every once in a while, but more often than not, these excess resources are wasted.
Ignorance of basic social needs- There are many basic social sectors like literacy, poverty, public health, water supply, social welfare and social security. Since the possible profit that can be gained from these sectors is very low, capitalists will simply be against involving themselves in such businesses, leading to no investment. As a result, majority of the important human problems will be overlooked in a capitalist system.
To evaluate, the market economic system is by far the most effective economic system. However, it is also the most dangerous if used the wrong way. It guarantees and stimulates economic growth but the side effects can be very damaging. An example of a country using this system is the United States of America. The U.S.A claim to practice the capitalist economic system but the government intervention is not as limited as in most other countries practicing this system. The high level of government intervention that occurs in the U.S.A is one of the reasons behind their dominance in the global economic market. Government intervention plays a huge part in the success of a country's economy. Although the market transactions of a market economy are done by the private individuals, the government can still generate enough money to provide enough demerit goods for the society. The private individuals cannot be bothered about producing these demerit goods as it is non-profitable so if the government also decides to ignore the importance of providing demerit goods to the society then market failure is inevitable.
Market failure occurs when firms in a free market economy fail to produce some goods. It also occurs when there is misallocation of resources. Other causes of market failure also include:
Inequality- This is the gap between the rich and the poor. If this gap is too wide, the rich would tend to exploit the poor by taking advantage of their status. This can lead to unfair circulation of money in the system and subsequently lead to market failure.
Consistent price fluctuations- In some markets, there can be huge price fluctuations over a short space of time. Constant fluctuations in these prices can give a very confusing image to producers and lead to over-production or under-production of a good in the short-term and lead to over/under-investment in the long term. This in turn would cause misallocation of resources and subsequently lead to market failure.
Monopoly- Even though monopoly is a market situation experienced in this system, it can also lead to market failure in the sense that the private firm dominating this market dictates the price of that product to the consumers regardless of the consumer's demand. Once consumers are unwilling to purchase the good at such a high price, excess supply is inevitable because of the over-production. There will be misallocation of resources in the long run which will subsequently lead to market failure.
In the final analysis, the market economic system- with proper management of private individuals and adequate government intervention- can prove successful to any country. But without a balance between the producer's freedom and government's control, ineffective resource allocation will occur. To this, it can be deduced that the market system cannot allocate resources efficiently.
