U.S. ECONOMY > An Overview of the U.S. Economy > What is a Market Economy?

What is a Market Economy?

By Michael Watts

Introduction
Command and Market Economies
Consumers in a Market Economy
Business in a Market Economy
Workers in a Market Economy
A System of Markets
Finances in a Market Economy
Government in a Market Economy

WORKERS IN A MARKET ECONOMY

The stream of workers going to their jobs on any work day can look very much alike in both market and command economies that have attained similar levels of industrialization. But once again, there are hidden differences in how the two systems function that are far more important than the apparent likenesses.

Choices

Let's take the example of the family who earlier went to the supermarket and bought oranges -- along with some apples since the price of oranges was a bit higher than they expected. After having dinner and putting their children to bed, Robert, who is, as we noted, a machinist, and Maria, a schoolteacher, discuss the options that are open to them in their careers. This is by no means a regular occurrence; but at key points in their lifetimes, workers in a market economy must make important decisions about their careers. Why? Because no one else will make such decisions for them, since there is no central planning organization that determines who will work where for what amount of money.

Robert is concerned that his opportunities for advancement as a machinist are limited, and he is considering a course of study in computer programming that may offer wider opportunities. For Maria, there is opportunity for advancement to a more demanding administrative position in the school system.

Thousands of workers face these kinds of economic decisions every year. How Robert and Maria decide these questions will depend on a number of factors, both personal and economic. As a middle-class couple with children, for example, their decisions will be different than for a single person who has just finished secondary school or college, or for someone who is nearing retirement age.

For Maria, the question is whether she wants to trade the satisfactions of classroom teaching for the higher pay but higher pressure and longer hours of a more senior administrative position.

Robert faces the critical question of whether or not to attend college or some other kind of training program with the hope that his new skills will command a higher salary and wider opportunity for advancement. For Robert, whether this is a good investment from an economic point-of-view depends on a number of factors:

• How much does Robert earn now, without the additional education and training? The higher his current wages, the more income he will have to give up by leaving his machinist job to complete college or another training program.
• How high would his tuition and other costs be to attend a college-level or another kind of computer training course? The higher those costs, the lower the gain will be on this kind of personal investment, and the smaller the number of people, like Robert, who will enroll in these programs.
• How long is the coursework or training relative to the potential job rewards? Robert may find that a relatively easy six-month training course has greater payoffs than a rigorous graduate-level program at a university.
• Robert's age is also a factor. Younger workers obviously have more years to earn back the money they gave up by leaving their jobs, as well as the other costs of schooling.
• How much will Robert earn after computer training? The larger the difference between this amount and his current earnings, the more likely that he will seriously consider enrolling in such a training program.
• How likely is Robert to find a job in this area of work after graduation?

These factors vary considerably for different people, which is why not everyone should go to college or take other training programs, at least in terms of making a sound financial investment in their own careers. For some people the costs are simply too high compared to the expected benefits. For others -- including many bright young students who don't hold jobs paying high wages now -- college or other training programs are almost always good "business" investments.

As in the case of Robert and Maria, these decisions rest upon much more than just financial considerations. But just like firms considering investments in new plants and equipment, workers in market economies bear clear costs and risks in acquiring additional education and training. And frankly, some of those investments don't pay off, because not all people who go to college succeed there or in the labor market after they graduate. For many, lower-paying but secure employment may be very attractive, offering valuable time and opportunities to devote themselves to family or to other personal and professional pursuits. Still, for most workers in market economies, the risks of education and training have been well worth taking over the past few decades, and increasingly so in recent years as economies become more technological and complex.

Workers and Employers

The example of Robert and Maria, and the millions of workers like them, points to another fact about market economies. Without a central planning organization, workers and their employers determine their relationship through a series of independent decisions. This doesn't mean that they always negotiate as equals, or that workers are always happy with their jobs and rates of pay. But it does mean that employees and employers have a great deal of freedom in deciding to begin, change, or end their relationship. And that raises a basic question: what keeps a worker and firm together in a market economy, or leads them to change their relationship?

As the case of Robert and Maria illustrates, the kind of job a worker has in a market economy depends first and foremost on his or her individual interests, training, and skills. People are free to pursue any career they choose, but only those who are able to meet basic performance standards in the jobs they choose will remain on an employer's payroll. In competitive markets, firms simply can't afford to keep paying workers who can't, or won't, do the jobs they were hired to do. But by the same standard, workers who make solid contributions to a firm's production of goods and services are very valuable employees whom many different firms would like to employ.

To keep the services of those current workers, firms have to offer competitive wages and terms of employment compared to other firms. That competition among workers looking for good jobs, and firms looking for good workers, is a constant activity in most labor markets.

The wage rates that firms will pay to workers are mainly determined by the productivity of workers, and by the relative scarcity or abundance of workers with those skills. In general terms, workers who can make or do things that many consumers like, and that only a small number of people are able to do, will command the highest wages.

Other factors influence that relative scarcity, however. For example, unpleasant or dangerous working conditions can mean wage and salary premiums for those workers, because many people aren't willing to do those jobs. Coal miners generally make more than file clerks; steelworkers who build skyscrapers earn more than general laborers who dig foundations for such buildings.

Education and Training

Jobs that require more training and education also tend to command higher salaries, other things being equal, because, as Robert knows, these workers give up years of working to acquire the skills necessary for access to the higher-paying jobs -- and because the education itself requires intelligence and hard work to complete. Engineers and architects are, on average, highly paid in most market economies -- in large part for these reasons.

Training, education, and level of effort may all influence income, but one very important factor is society's demand for a particular skill or line of work. Skilled plumbers or electricians often command higher fees than carpenters or auto mechanics; but a carpenter who is a skilled cabinetmaker or a master mechanic may be in extremely high demand and command high wages that reflect the value of his or her skills.

The supply side of the equation works in a similar fashion in labor markets. At most universities in market economies, for example, philosophy and language professors have received lower salaries than engineering and science professors for several decades now, simply because there are so many more of them compared to the demand for their services. A large number of people can qualify to work as retail clerks in stores, which is one reason that wage rates of such jobs tend to be low relative to jobs where the number of qualified persons are fewer.

Prices and Wages

The education and training issue also shows that the decisions workers make in labor markets are, once again, strongly influenced by various prices, and especially by wage rates. These prices for labor are in turn influenced by the demand for the products and services for which workers are hired. As a result, wages in different occupations rise and fall over time in large part because of changes in the prices for those consumer goods and services. For example, as automobiles replaced horses in the first part of the 20th century, the wages of blacksmiths and saddlemakers fell sharply, while the wages for auto mechanics rose.

Similarly, in just the past few years, the demand for workers with college degrees has increased sharply in most market economies, largely because most businesses now work with more sophisticated technologies than they have in the past. Robert is attracted to computers, in part, because he sees it as a growing field with relatively high demand and, consequently, high wages.

International trade can also be an important factor in determining overall demand. Industries and companies that can compete successfully and export to foreign markets open more jobs and career opportunities for workers -- just as imports from these countries offer them, as consumers, a wider choice of goods at competitive prices.

Workers who prepare for careers that experience strong growth in demand will gain from their foresight. Those who try to cling to jobs in declining markets using traditional skills will often be disappointed, and may even find themselves unemployed. They will need training, whether provided through their own resources, by government, or by their employer. But that, too, is part of the strong system of incentives that directs more resources -- labor resources in particular -- into the production of goods and services that consumers want most, and away from those no longer in demand.

This constant emphasis on producing what consumers want is, over time, the most fundamental reason why labor and other resources are so productive in market economies. The lesson is clear: to prosper, produce what people want and need.