How does a market economy work?

[Damien Molnar]

A market, by definition consists of all buyers and sellers (groups or not) willing and able to exchange a particular good or service.

A pure market economy is one in which the government has no involvement. In reality, this will obviously not be desirable due to the benefits of public goods and externalities.

Due to the free-rider probem, public goods won't be provided by an unregulated market and thus the government must step in and correct this market failure.

The reason underlying market failure is that the total benefits (demand) and costs (supply) of consumption/production are not reflected in the market as individual decision makers are motivated only by self-interest. They do not consider the environment or additional benefit of immunisations, for example.