Market Economy : Origins and The Great Depression

Market Economy

What’s an economic system?

An economic system can be considered as an arrangement by which the government plans and organizes the production of goods and services and their allocation across the region, along with the mechanism for their exchange. An economic system influences the dynamics of production, like the ownership of productive assets such as land, machinery, and labor. And the mechanisms of their supply. For example – in a market economy, all the goods produced are bought and sold in a free market without any central authority or government intervention. Whereas in a non-market economy, the government has sole authority over all the means of production and the goods produced, and most of the goods are directly allocated to people by the government, in the absence of a free market.

Market Economy
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Different types of economic systems-

In this blog, we’ll be discussing the capitalist/market economic system.

Market Economy

In a market economy, the means of production are owned by individuals and private entities, and the goods are distributed and exchanged in a free market. The markets are not regulated by a central authority or the government and there is very little or no intervention by the government. Adam Smith called this system the system of natural liberty.

Market Economy
word cloud – market economy

Market Economy: Origins

Market Economy is the first formal economic system. This economic system was first introduced by Scottish Economist Adam Smith in his historical work, An Inquiry into the Nature and Causes of the Wealth of Nations, which was published in 1776. Adam Smith is also considered the father of modern economics. 

Market Economy
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The characteristics of the market economy as explained by Adam Smith are-

  • Individuals are driven by self-interest, which motivates them to carry out economic activities like the production of goods. And due to the selfish motives of individuals, society gets the goods that it requires. This motivating factor (self-interest) is considered as an invisible hand. 
  • For the efficient functioning of this system, a free market, which is determined by the forces of demand and supply is a prerequisite. And every single decision in the system such as what to produce, how much to produce, and at what prices to sell, are completely determined by the forces of demand and supply. If the demand for certain goods increases, and supply doesn’t, prices hike. And if the demand decreases, and supply remains high, prices crash.
  • The markets are regulated by the competition, as the competitive pressure caused by numerous producers in the market keeps prices and quality of goods in check. The laborers also compete with each other for high-paying jobs. So, we can consider that Competition is the regulator of this system.
  • The government must follow a policy of laissez-faire (French for ‘leave it alone’), which means that the government interference in the markets should be limited. The term ‘Non-interference ‘ can have different interpretations such as the government producing none of the goods and services, not imposing any regulations, no taxation, etc. However, there’s a consensus that the government should play an active role in penalizing monopolies that restrict competition and should also prevent the manipulation of the markets. It should also ensure that everyone has equal access to the market. 
  • For higher prosperity, there should division of labor and specialization (breaking down big jobs into smaller components). This would lead to the enhancement of the labor force.

These policies were democratic and supported the principle of liberty and freedom. The system paved the way for innovation and individual success with the smooth functioning of business operations.

History of Market Economy

The system of market economy, referred to as capitalism, was first initiated in the USA in 1777. From the USA, the concept of capitalism spread to Europe, Western Europe to be specific. The economies of these countries prospered greatly, and their influence in the world grew rapidly due to the dynamic economy.

The Great Depression

However, the system failed, and so did the economies with the advent of the Great Depression of 1929. Wall Street collapsed in 1929 due to the massive selloff of overpriced stocks, which drained millions of dollars of large capitalists. On 29th October 1929, around 16 million shares were traded! A large chunk of investible capital was drained and investments in industries plunged. The consumer demand remained sluggish in this period and so did the industrial output. All this led to widespread unemployment and beggarliness. Nearly 15 million Americans were unemployed and most of the banks collapsed.

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At the time of the depression, most of the capital was amassed by the capitalists, owning large multi-national companies, while the majority of the population remained poor. Hence, there was wide income inequality. The government’s inaction was a major reason for this inequality. As the governments played a negligible role in intervening in the economy. Governments did imposed taxes, but the rates were very low, which were again negligible.

Hence, the limitations of the market economy were clearly evident after the depression, which can be summarized as-

  •  The Government was dysfunctional in playing the welfare role for the poor. So, there was no one to look after the laborers and poor. There was very little or no regulation over the companies, they did not have the policies of fixed working hours or minimum wages, ultimately leading to the workers being exploited. And due to very little or negligible taxation, there was no redistribution of wealth to the poor, leading to widening income inequalities.
  • Due to the policy of laissez-faire, governments did not interfere or provided additional support to the economy even when the economy required. The Depression couldn’t have been stopped, but the effects could very well have been mitigated if the governments would have intervened.

John Maynard Keynes: Blessing in disguise

John Maynard Keynes. Foreign Policy illustration/Gordon Anthony/Getty Images

In the wake of the economic depression, when the existing policy approaches by the government failed to solve the crisis, a new branch of economics emerged. Macroeconomics was proposed by the British economist John Maynard Keynes in his work The General Theory of Employment, Interest, and Money. In his work, Keynes analyzed the causes of the depression and proposed new economic policies which would help to solve the crisis. In a nutshell, Keynes suggested the countries move to the mixed economic system i.e to include certain traits of non-market economy into their economic policies. This led to the emergence of the mixed economic system.

Learn about other economic systems

Non-Market Economy

Mixed Economy

Interested in economics? Check out our other articles-

Bad Bank : Reconstructing the Reconstructors

National Income : GDP, GNP, NDP and NNP

NPA: Causes and Effects

Bad Bank : Solution to the banking crisis?

Bond Yield : Factors influencing the yields

Shell Companies: Are Shell Companies the Future?

Fiscal Deficit: Implications and Benifits

Buy The Wealth of Nations by Adam Smith

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