Which of the following statements is true about a market economy?

• A. The government sets all prices for goods and services.
• B. Prices are determined by the interaction of supply and demand.
• C. Resources are allocated solely based on tradition and custom.
• D. Production decisions are made exclusively by central planners.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of a market economy. In a market economy, economic decisions such as pricing, production, and resource allocation are primarily determined by the interactions between buyers and sellers in the marketplace.
2. Step 2: Recognize that in a market economy, prices are not set by the government or central planners. Instead, prices emerge from the forces of supply and demand, reflecting the willingness of consumers to buy and producers to sell.
3. Step 3: Contrast this with other economic systems: a command economy involves government or central planners setting prices and production; a traditional economy relies on customs and traditions to allocate resources.
4. Step 4: Analyze each statement: 'The government sets all prices' aligns with a command economy, not a market economy; 'Resources allocated based on tradition' describes a traditional economy; 'Production decisions made by central planners' also describes a command economy.
5. Step 5: Conclude that the true statement about a market economy is that prices are determined by the interaction of supply and demand, which is the fundamental mechanism driving resource allocation and production decisions in such an economy.