Which of the following statements about market economies is correct?

• A. Resources are allocated solely based on tradition and custom.
• B. Prices are determined by the interaction of supply and demand.
• C. Firms are prohibited from making profits.
• D. The government sets all prices for goods and services.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of a market economy. In a market economy, economic decisions and the pricing of goods and services are guided by the interactions of individuals and firms in markets, rather than by central planning or tradition.
2. Step 2: Analyze the role of prices in a market economy. Prices are signals that reflect the relative scarcity and demand for goods and services, and they are determined by the forces of supply and demand interacting in the market.
3. Step 3: Evaluate the incorrect statements: (a) Resources allocated solely based on tradition and custom describes a traditional economy, not a market economy; (b) Firms being prohibited from making profits contradicts the profit motive fundamental to market economies; (c) Government setting all prices describes a command economy, not a market economy.
4. Step 4: Conclude that the correct statement is that prices are determined by the interaction of supply and demand, which is the defining characteristic of a market economy.
5. Step 5: Summarize that in market economies, decentralized decisions by consumers and producers, guided by price signals, allocate resources efficiently without central government control over prices.