Market economy or free market economy functions primarily depending upon the forces of the market, namely demand and supply. The institution of the market allocates and distributes commodities based on the principle of price determined by the interaction of the forces of the market. Price of a commodity generally shoots up when its demand exceeds supply and when the reverse occurs, it is generally associated with price cuts of the good in question.
The advantages of a market economy can be summarized as:
But in a practical world which is imperfect by nature, prices are never at equilibrium and very volatile depending upon the vagaries of the market forces. This generally harms people living below the poverty line or those in the low income group. It is impossible for them to pay high prices in cases of demand shortage and thus the free market model is not a viable option in developing countries which has a large number of poor.
Free market and liberalization with increased competition has increased unemployment levels and poverty in India and China with the growing divide between the rich and the poor. Growing at an average of 10% per year since 1978, increased levels of efficiency and prosperity have not percolated to the grassroots level. Developed economies such as the USA and Canada are also facing limited problems of poverty and unemployment as a result of total free market economy.
Free market economies, although have been successful in developed economies, will not be so in developing countries and the only recourse for them is the model of the mixed economy or social market economy. The welfare role of the state is retained in a social market economy which cares for the poor. In cases where the poor countries are striving towards a free market economy, there should be certain segments controlled by the state but with prevalence of free enterprise such that efficiency is restored and the country moves towards economic prosperity. Free market economy under centralized political control is the most effective way for these countries.