Market economy can be defined as the economy in which all the decisions are taken on the basis of demand and supply and free price system. In a market economy, decisions related to production, investment and distribution are dependent on the demand and supply and free price system or free price mechanism is used for determining the prices of goods and services.
A market economy’s most important characteristic is that any decision regarding investment or allocation of goods is made mainly through the market. It is completely different from a planned economy. In a planned economy, all decisions related to investment and production is made by the state; that is government makes all decisions regarding the allocation of resources.
Market economies can be of various types like it can be a variant of free market and laissez-faire or an interventionist and regulated market. There is no existence of pure market economies in reality. This is because; both government and society regulate the decisions regarding allocation of resources to varying extent. Most of the market economies that exist have a degree of state directed activity or economic planning and are known as mixed economies. The market economy is sometimes called free market economy, but the term may also mean free-market anarchism or laissez-faire.
It is not logically assumed in market economy that private property exists in the means of production. Market economies can have various types of cooperatives, autonomous or collective state agencies that are involved in buying and selling capital goods with one another in a free price system. Market socialism has many variants which include employee owned enterprises that are built on self management and that function in markets, and also there are models which have public ownership of the means of production and in which distribution of capital goods in done through markets.
The use of the term market economy can be to some extent misleading. For instance, U.S. represents mixed economy having significant government funded research and development, agricultural subsidies, Medicare, considerable market regulation, though it’s foundation is market economy. There are different viewpoints regarding the role government should play in guiding the market economy and dealing with the inequalities that the market creates.