Cambridge Notes, Past Papers, Revision Questions

Cambridge IGCSE Economics 0455 – Market Economic System

Allocation of Resources – Market Economic System

Objective

Define the market economic system and outline its key characteristics.

Definition

A market economic system, also known as a free‑market or capitalist system, is one in which the allocation of resources, production, and distribution of goods and services are primarily determined by the decisions of private individuals and firms operating in competitive markets. Prices are set by the interaction of supply and demand, and the profit motive guides economic activity.

Key Features of a Market Economy

Private ownership of resources and enterprises.

Decision‑making by households and firms based on self‑interest.

Freedom of choice for consumers and producers.

Competition among firms.

Price mechanism (supply and demand) determines resource allocation.

Limited government intervention (primarily to enforce contracts and protect property rights).

How the Price Mechanism Works

The price mechanism coordinates the decisions of buyers and sellers through the following steps:

Consumers express preferences by demanding goods at various prices.

Producers respond to price signals by adjusting output.

If demand exceeds supply, prices rise, encouraging firms to increase production.

If supply exceeds demand, prices fall, prompting firms to reduce output or exit the market.

Resources are reallocated to the most valued uses as indicated by price changes.

Comparison with Other Economic Systems

Aspect	Market Economy	Planned Economy	Mixed Economy
Resource Ownership	Private	State	Both private and state
Decision Makers	Consumers & firms	Government planners	Consumers, firms, and government
Price Determination	Supply and demand	Government set	Market forces with government regulation
Role of Profit	Primary driver	Irrelevant	Important but may be moderated
Government Intervention	Minimal	Extensive	Selective

Suggested Diagram

Suggested diagram: The price mechanism – interaction of supply and demand curves showing equilibrium price and quantity, and how shifts affect resource allocation.

Summary

In a market economic system, the allocation of resources is guided by the price mechanism, which reflects the collective choices of individuals and firms. This system encourages efficiency, innovation, and consumer sovereignty, while the role of government is limited to maintaining the legal framework that supports market operations.

Definition of the market economic system