Back to: ECONOMIC ANALYSIS & MONETARY POLICY
Free Market Definition
A free market is an economic term that refers to a system where there is slight or complete regulation of supply and demand for goods and services by the government. In a free market, the determination of prices of goods and services is through evaluating consumer and the open market trends.
The system is contrary to the regulated market where the governments have control over the supply and demand of goods and services. In a regulated market, there is a restriction of trade and protection of the local economy by the government through tariffs.
A Little More on What is a Free Market
A free market may also refer to as laissez-faire capitalism. It is an economic system where buyers and sellers privately transact their business without any obstructed competition.
For instance, businesses are able to sell their goods and services at the maximum price buyers are willing to pay. On the other hand, the buyers are able to go for the available lowest price deals for the products and services.
When it comes to workers, their skills level is what determines the wage charges. Meaning that they are free to charge the highest wages their skills allow. For employers, they look out for skilled and competent employees with the lowest wage rates.
Generally, activities in the free market are voluntary. The prices of goods and services are free to reach their equilibrium point without the government imposing restrictions such as:
- Quality controls
- Tariffs, etc.
Economists and the Free Market Theory
According to economists, the theory of free-market asserts that for one to become better, other individuals are made worse under certain conditions. In a free market, there are those actors with personal interests. Since they are free to make an economic decision, they often make decisions that satisfy their interests, including those with the same interest as theirs.
However, there is an argument from some ethicists that free-market efficiency is highly dependent on various moral parameters like:
- Fair play
- Equal partnership competition
Free Market Concepts
There are two concepts market dealers use to shape a free market that is worth noting:
- Supply and demand
Supply and demand is an economic model showing how the market prices of goods and services are determined. Demand for goods and services is represented by the pressure people display buying the products.
There is always a maximum price consumer is ready to pay, as opposed to the minimum selling price on offer. Also, the current economic market conditions influence the way prices, and the number of items is adjusted.
- Low entry barriers
A free market is supposed to provide low entry barriers. Though it doesn’t need competition for it to exist, it should, however, open doors for other business dealers. Lack of barriers with little or no entry costs will ensure increased competition in the free market.
Free Market Principles
The fact there are various variables that are used to explain a free market, we have a set of measures that are generally accepted. The measures are created to help determine the activities in the market economy. Note that these are the same principles that were implemented in the United States, enabling it to move toward a free-market economy. The variables fall under the following categories:
- Government intervention
- Monetary policy
- Trade policy
- Capital and foreign investment flows
- Wages and prices
- Finance and banking
A Free Market Common Constraints
Explicit or implicit threats of force are what a free market uses as constraints. Some examples of these include:
- The taxation
- Employee hiring practices
- Quotas on production
- Specific terms and exchange
- Purchase of goods
- Price control
- Prohibition of specific exchange
- Licensing requirements
- Competition from publicly provided services
- Fixed exchange rates
Generally, even with the governments’ regulations, voluntary buying and selling can still take place. Such exchanges that happen against the government’s set regulations happen in what we call the “black market.” The black market is a version of the free-market, but for in this type of market, business deals are done underground (secretly).
Pros of Free Market
The free market has the following benefits:
- Absence of Bureaucracy
Due to the absence of red tape, free markets tend to reduce costs. As a result, there is increased research and innovation as well as development, to improve customers’ needs. The reason is that in free markets, the entrepreneurs are free to make decisions. They don’t have to wait for the government’s opinion or directions to do so. Independence ensures that there is an improvement in products and services among the competing companies.
- Optimal Allocation of Resources
There are proper distribution and allocation of resources in the market. The willingness of consumers to pay for a given quantity of products, manufacturers are ready to pay for the raw materials. It encourages efficiency among companies enabling them to maximize profits by ensuring that the cost of production is at its minimum.
- Consumer Sovereignty
In a free market, producers always consider what the consumers want during production. They also ensure that the prices of products are affordable.
- Free Enterprise Motivational Influence
Entrepreneurs usually take risks to ensure that they meet customers’ demands. Those who take such risks get rewards with higher returns. There is an invisible hand where the market demand becomes an indicator for producers.
For instance, if consumers are willing to pay for product A, the producer will find the motivation to produce that particular product.
Cons of a Free Market
- Merit Goods
In a free market, there is no production of goods and services that are not profitable. As a result, the rural community ends up suffering for they have to incur transportation costs to reach certain goods and services.
A good example is the rural hospitals. As much as they are not profitable, they are indeed necessary. So, people who need treatment have to incur transportation costs to access medication.
- Firm Power
Big companies can still have dominance in a market full of competitors and still be able to exploit suppliers and consumers. They are able to squeeze supplier’s prices downward, and at the same time charge higher selling price on the products. A good example is Amazon. It has been able to dominate the book industry, where it always dictates unfair terms to publishers.
- Poor Quality
The biggest motivation for most companies is to ensure that they maximize profits. So, in their quest to maximize profits, they unethically reduce their costs by exploiting workers and polluting the environment.
Since there is no government to take care of people’s interests, people may end up becoming jobless. In a free market, some members of society may not be able to get jobs because their skills are no longer marketable.