A market economy (or free-market economy) is an economy in which decisions regarding investment, production and distribution are based on supply and demand[1] and the prices of goods and services are determined in a free price system. This is contrasted with a planned economy, where investment and production decisions are embodied in a plan of production. Market economies can range from hypothetical laissez-faire and free market variants to regulated markets and interventionist variants. Most existing market economies include a degree of economic planning or state-directed activity and are thus classified as mixed economies.
In a true market economy, the government allows and protects ownership of property and voluntary exchange. In such a society, government plays an important role as the protector of property rights and individual liberty.
In the real world, market economies do not exist in pure form, as societies and governments regulate them to varying degrees rather than allow full self-regulation by market forces. The term free-market economy is sometimes used synonymously with market economy, but, as Ludwig Erhard once pointed out, this does not preclude an economy from providing various social welfare programs such as unemployment benefits, as in the case of the social market economy.
There are many variations of market socialism ranging from the cooperative model, where employee-owned enterprises based on self-management are coordinated by markets and output of final goods and services is based on market allocation, to those based on public ownership of the means of production.
The term used by itself can be somewhat misleading. For example, the United States constitutes a mixed economy (substantial market regulation, agricultural subsidies, extensive government-funded research and development, Medicare/Medicaid), yet at the same time it is foundationally rooted in a market economy. Different perspectives exist as to how strong a role the government should have in both guiding the market economy and addressing the inequalities the market produces. This is evidenced by the current lack of consensus on issues such as central banking and welfare.