What’s it: A free market is an economic system in which the forces of demand and supply drive all economic activity. In a pure system (laissez-faire), the role of government in the economy is zero. In this economic system, companies and property belong to individuals or entities in the private sector.
The free market is in contrast to a command economy. In a command economy system, the central government and its institutions decide all economic activity.
Characteristics of a free market economy
In a free or pure market economy, market demand and supply determine prices. Market prices are a signal for producers to change their production.
But, in the real world, such economic systems are rare. There are countless barriers to free markets, including price controls, subsidies, import and export tariffs, and legal restrictions such as age restrictions on alcoholic beverages.
Overall, the capitalist economy, which is practiced by most developed countries such as the United States of America, is not a purely free market. They are free only because the private sector plays a significant role in the economy.
The following are characteristics of the free market:
- Ownership of economic resources by private and private sectors
- Developed financial market
- Freedom to participate
- Voluntary exchanging
- Economic incentives encourage individuals to be the best
- No government intervention
Ownership of resources by private and private sectors
A free economy exists because most economic resources are owned by individuals or companies in the private sector. It contrasts to command economy, in which the government owns all of it.
In a free market, the owner owns and has full control over the means of production, allocation, and exchange of products. They also control the supply of labor.
Financial markets are growing.
One of the critical factors that help free-market economies to be successful is the existence of advanced and efficient financial institutions. Financial markets develop to facilitate the financing needs of those who are unable or unwilling to finance themselves.
Banks and brokers exist to provide individuals and companies with the means to exchange goods and services. The financial institution then makes a profit by charging interest or transaction fees.
Freedom to participate
In a free-market economy, each individual can take part and participate in economic activities. It is the individuals who make economic decisions. Also, there is no coercion or restriction related to economic activities.
The decision to consume or produce a particular product is entirely voluntary. There is no intervention or coercion from the government. Thus, companies or individuals can make as much or as little of the product as they want.
Individuals have the right to make exchanges that they believe will make them better off. Individuals make themselves better off by buying lower value resources and selling higher-value resources.
Individuals are free to compete with each other. That is also true with companies. In this case, the government must ensure that competition is fair and provides equal opportunities. Through antitrust laws, the government prohibits practices that tend to harm, such as monopolies and cartels.
Money acts as an incentive for production and the better. When we produce goods and services that people want and can buy, we receive money in return. The more money we have, the higher our position economically.
Minimal government intervention
In a pure free market, the role of government is absent. For an economy close to a free market, government intervention is limited to that the state’s enforcement of individual property rights is protected. Also, the government prohibits practices that inhibit competition to provide fair opportunities for all economic actors.
Advantages and disadvantages of free market
Free market advantages
In a free-market economy, companies have the freedom to determine output, price, and make a profit. More specifically, a free-market economy has several advantages, including:
- Consumers drive choices
- Freedom to innovate
Customers drive choices
Consumers decide which products are successful and which are failures. When presented with two product choices, consumers evaluate each other’s features and choose the one that offers them the best value.
To a large extent, consumers also influence the price set on a product. Thus, producers need to find a balance between the price point and cost (including the cost of differentiating products).
Business owners enjoy all the freedom to generate new ideas to meet consumer needs and make a profit. They can make new products and offer new services whenever they want. Because of this, entrepreneurs rarely rely on government agencies to inform them of consumer needs.
As producers work to meet consumer demand, they are also looking for ways to gain an advantage over their competitors. It can happen by making the production process more efficient. It can also occur when new technical innovations lead to new markets.
Free market disadvantages
Apart from the benefits, a free economy also comes with several disadvantages, including:
- Market failure
- Small businesses get rid of
- The danger of the profit motive
At times, a free market economy can spiral out of control, causing dire consequences. Examples of market failures include the Great Depression of the 1930s due to the stock market crash. Most recently, the real estate market crash that occurred in 2008 is another example of the failure of free-market economies.
Small businesses get rid of
Large companies enjoy an advantage over small producers who do not have the resources to compete. They easily access the pool of capital and labor.
Such conditions can result in producers driving rivals out of business by cutting their prices or controlling the supply of scarce resources.
The danger of the profit motive
In a free-market economy, producers seek to maximize profits. This motive guides them in allocating resources most profitably, whether it is harmful or not.
Such motives may lead to exploitative attitudes towards resources, including labor and natural resources. As a result, it often compromises and even jeopardizes workers’ safety or ignores environmental standards and ethical behavior.
They only think about how to generate supernormal profits. The profit motive is also responsible for the negative externalities that arise and affect the global climate, such as air pollution, greenhouse gas effects, etc.