Market socialism is distinguished from the concept of the mixed economy because unlike the mixed economy, models of market socialism are complete and self-regulating systems. Market socialism also contrasts with social democratic policies implemented within capitalist market economies: while social democracy aims to achieve greater economic stability and equality through policy measures such as taxes, subsidies and social welfare programs, market socialism aims to achieve similar goals through changing patterns of enterprise ownership and management.
Although economic proposals involving social ownership with factor markets have existed since the early 19th century, the term "market socialism" only emerged in the 1920s during the socialist calculation debate. Contemporary market socialism emerged from the debate on socialist calculation during the early-to-mid 20th century among socialist economists who believed that a socialist economy could neither function on the basis of calculation in natural units nor through solving a system of simultaneous equations for economic coordination, and that capital markets would be required in a socialist economy.
Early models of market socialism trace their roots to the work of Adam Smith and the theories of classical economics, which consisted of proposals for cooperative enterprises operating in a free-market economy. The aim of such proposals was to eliminate exploitation by allowing individuals to receive the full product of their labor while removing the market-distorting effects of concentrating ownership and wealth in the hands of a small class of private owners. Among early advocates of market socialism were the Ricardian socialist economists and mutualist philosophers. In the early 20th century, Oskar Lange and Abba Lerner outlined a neoclassical model of socialism which included a role for a central planning board (CPB) in setting prices equal marginal cost to achieve Pareto efficiency. Even though these early models did not rely on genuine markets, they were labeled "market socialist" for their utilization of financial prices and calculation. In more recent models proposed by American neoclassical economists, public ownership of the means of production is achieved through public ownership of equity and social control of investment.
The key theoretical basis for market socialism is the negation of the underlying expropriation of surplus value present in other, exploitative, modes of production. Socialist theories that favored the market date back to the Ricardian socialists and anarchist economists, who advocated a free-market combined with public ownership or mutual ownership of the means of production.
Proponents of early market socialism include the Ricardian socialist economists, the classical liberal philosopher John Stuart Mill and the anarchist philosopher Pierre-Joseph Proudhon. These models of socialism entailed "perfecting" or improving the market-mechanism and free-price system by removing distortions caused by exploitation, private property and alienated labor.
Mill's early economic philosophy was one of free markets. Later he altered his views toward a more socialist bent, adding chapters to his Principles of Political Economy in defence of a socialist outlook, and defending some socialist causes. Within this revised work he also made the radical proposal that the whole wage system be abolished in favour of a co-operative wage system. Nonetheless, some of his views on the idea of flat taxation remained, albeit altered in the third edition of the Principles of Political Economy to reflect a concern for differentiating restrictions on "unearned" incomes, which he favoured, and those on "earned" incomes, which he did not favour.