It is characteristic of any society that while wants of people are growing constantly, the economic resources required to satisfy these wants are limited and scarce. Economic resources may be classified as material resources (raw materials and capital) and labour resources (labour force and entrepreneurship). Scarcity of resources makes it necessary to save them. As a result any economic system is trying to find most effective and efficient ways of utilizing resources for the production of goods and services. The rational solution of the problem brings about the maximum economic growth, full employment, stable prices, equitable distribution of revenues, and social security of the needy.1
There are different economic systems in the world today. Many economists argue that free enterprise, or the market economy is the most effective system, because businesses are free to choose whom to buy from and sell to and on what terms, and free to choose whom to compete with. How can a market economy solve what, how and for whom to produce?
It is done through a market, which is a set of arrangements through which buyers and sellers make contact and do business, in which choices concerning the allocation of resources and transactions among members of society involving factors of production, incomes, goods and services are left to countless independent decisions of individual consumers and producers acting on their own behalf.
One of the main laws of the market is the law of supply and demand. It says that if demand exceeds supply, the price tends to rise and when supply exceeds demand the price tends to fall.
Given the scarcity of resources,2 the market functions as a rationing device with the price mechanism as its principal instrument. In free, markets, prices direct allocations of inputs of firms that make the most profitable use of them. The price mechanism also guides the decisions of producers concerning the composition of their output. Finally, the price mechanism also governs the distribution process.
Thus, the market mechanism brings about an allocation of resources that reflects two basic factors: consumer preferences and production costs. The prices which play the coordinating role of the market mechanism are determined through the interaction of demand and supply.
Another important force of the market is competition. On the one hand, it protects the customers – they have the right of choice and they benefit from the fact that competition keeps prices close to costs; on the other hand, it makes producers and suppliers of scarce resources utilize them economically, using most sophisticated technologies.
All businesses produce goods and services and seek profits. They all compete with other businesses for inputs of labour, capital and natural resources, including foreign partners.
Freedom of enterprise is not total in the market economy. Businesses are subject to laws and government regulations.
Economic machines do not always run smoothly. They are subject to a business cycle that alternates between periods of rapid expansion and periods of recession in which outputs fall and unemployment rises.
Economic environment is determined by the economic policies of the government, fiscal and monetary policies being the major factors.3 So, if an economic system is to perform well4 it must deal with many economic challenges.