IGCSE Economics – Disadvantages of the Market Economic System
Allocation of Resources – Market Economic System
Objective: Identify the Disadvantages of a Market Economy
A market economic system relies on the forces of demand and supply to allocate resources. While it can promote efficiency and innovation, several inherent drawbacks limit its ability to meet the broader needs of society.
Key Disadvantages
Inequality of Income and Wealth – Resources are distributed according to purchasing power, leading to large gaps between rich and poor.
Market Failure – Situations where the market does not allocate resources efficiently, such as:
Externalities (positive and negative)
Public goods
Information asymmetry
Merit and demerit goods
Negative Externalities – Costs imposed on third parties (e.g., pollution) are not reflected in market prices, resulting in over‑production of harmful goods.
Positive Externalities – Benefits to third parties (e.g., education, vaccination) are undervalued, leading to under‑production.
Public Goods are Undersupplied – Non‑rivalrous and non‑excludable goods (e.g., national defence, street lighting) are not profitable for private firms, so the market provides too little.
Information Asymmetry – Buyers or sellers may have more information, causing inefficient decisions (e.g., used‑car market).
Business Cycles – Market economies are prone to periods of recession and inflation, creating uncertainty for households and firms.
Undermining of Social Objectives – Pure profit motive may conflict with goals such as environmental protection, health, and education.
Short‑Term Focus – Firms may prioritize immediate profits over long‑term sustainability or research and development.
Illustrative Table – Comparison of Disadvantages
Disadvantage
Explanation
Typical Economic Impact
Inequality
Resources flow to those with higher income.
Widening wealth gap; social tension.
Negative Externalities
Costs not borne by producer/consumer.
Over‑production of polluting goods; environmental damage.
Positive Externalities
Benefits not captured by market price.
Under‑investment in education, research.
Public Goods
Non‑excludable, non‑rivalrous.
Insufficient provision without government intervention.
Information Asymmetry
One party has superior knowledge.
Market inefficiency; possible fraud.
Business Cycles
Fluctuations in aggregate demand.
Unemployment during recessions; inflation in booms.
Suggested Diagram
Suggested diagram: A supply‑and‑demand graph showing a negative externality where the social marginal cost (SMC) curve lies above the private marginal cost (PMC) curve, leading to over‑production at the market equilibrium.
Summary
While market economies can efficiently allocate resources through price signals, they often fail to address equity, externalities, public goods, and information problems. Recognising these disadvantages helps explain why many countries adopt mixed economies, combining market mechanisms with government intervention to correct market failures and promote social welfare.