A free market economy is a type of economy that promotes the production and sale of goods and services, with little to no control or involvement from any central government agency. This economic system is primarily based on supply and demand. Order and power in a free market are decentralized, with individuals making all of their own voluntary economic choices.
In a free-market economy, firms and households act in their own self-interest to determine how resources get allocated, what goods get produced, and who buys the goods. A free market economy functions in the opposite manner as a command economy works, where the central government gets to keep the profits and choose how to use them.
Among all of the states throughout the globe, there is no entirely free market economy—all economies have some constraints upon them in the form of government regulations, to a greater or lesser degree. An absolutely free market does not include standard measures like import and export tariffs, prohibitions on certain products, sales taxes, and more.
Markets tend to be the freest in countries that emphasize the values of capitalism and private property, which naturally promote laissez-faire economics (a term often used synonymously with the idea of the free market).
Main Features of Market Economies
The central elements that make up a market economy include:
- There is voluntary production and consumption of goods, with overall freedom for every individual to make their own choices
- Overwhelmingly, there is private ownership and control of resources and property, including the means of production as well as the labor supply
- Self-interest is the primary motivator for all economic decisions
- The government’s role in the economy is limited (e.g. to preventing monopolies, allowing fair and equal access to markets for all, protecting the nation and its markets through military means)
- Competition creates overall efficiency and low prices
Advantages Of A Free Market Economy
Here are several of the key advantages of the free market system:
1. Consumer Sovereignty
In a free market, producers are incentivized to produce what consumers want at a reasonable and affordable price. In general, consumers have more choices for what goods and services to purchase. This choice is called Consumer Sovereignty.
2. Absence of Bureaucracy
Because free markets reduce cost and minimize red tape, they lead to more innovation via research and development. Entrepreneurs do not have to wait for the government to tell them what to make. They study demand, research trends, and meet their customers’ needs through innovation. This independence also encourages competition amongst firms to improve their products and services.
3. Motivational Influence of Free Enterprise
Guided by what’s often called the “invisible hand,” entrepreneurs take economic risks to fulfill consumer demand. Those entrepreneurs who succeed are rewarded with profits, so this tends to encourage innovation in the market as a whole.
The invisible hand is an economic concept where market demand acts as signals for producers. For instance, because consumers want and are willing to pay for bread, bakers have the economic incentive to produce bread. The concept was originally introduced by Adam Smith in his 18th-century work The Wealth of Nations.
4. Optimal Allocation of Resources
Resources (aka factors of production) in the market are better distributed and allocated. Since consumers are willing to pay for a certain quantity of a product, producers are willing to pay to acquire the raw materials required to produce that product. Otherwise, producers are likely to produce too much of a good that no one wants. In the same way, it also encourages firms to be more efficient as they seek to produce at the lowest price possible to maximize their profit.
Disadvantages Of A Free Market Economy
There are also significant disadvantages inherent in a free market economy. These are the most prominent:
1. Poor Quality
Since profit maximization is the biggest motivation for firms, they may try to reduce their costs unethically. In many cases, the drive for profit maximization actually incentivizes unethical behavior. Examples of harmful effects of unethical cost reduction measures include polluting the environment or exploiting (overworking, under-paying, preventing workers from unionizing etc.) workers. Government intervention is necessary to limit these harms.
2. Merit Goods
Goods and services that are not profitable will not be produced or run. Rural communities will suffer as a result. Examples include transportation and postal services, as well as rural hospitals, which are necessary despite the fact that they may not be profitable to run. In such cases, the government must provide these goods and services so that people do not go with their basic needs unmet.
3. Excessive Power of Firms
Large firms can still dominate certain markets, even where there is some competition. This allows them to maximize their profits by exploiting suppliers (by squeezing their prices down) and consumers (by charging higher selling prices).
For example, Amazon is guilty of such practices in the book industry, where they have dictated unfair terms to publishers. Part of the reason that large companies are able to dominate markets is due to economies of scale. The large-scale companies with greater capital and labor resources can beat out smaller companies simply for their size alone, rather than for the quality of their product; if this process continues, they may eventually gain a monopoly over their market.
4. Unemployment and Inequality
In a free market economy, certain members of society will not be able to work, such as the elderly, children, or others who are unemployed because their skills are not marketable. They will be left behind by the economy at large and, without any income, will fall into poverty. Their caretakers will also be left out of the economy, because they will not be paid for their necessary caretaking work.
Remember: if there is no government, there is no way that these individuals can be helped in any systematic manner. The result is that inequality takes root: a few people can live in luxury while others cannot pay their medical bills, get enough food, access basic shelter, and so on.
Disadvantage:
Once a good or service becomes unprofitable, it will not be produced, leaving those who need it in a bad situation. Examples might be medicine, road maintenance, social services.
well road maintenance is usually by a government agency and so are social services.
medicines are still produced
its not like a command economy does a better job…
Are we restricted to extremities?
Prateek,
Question: How does a free market make it where children and the elderly cannot work nor receive help? Also, caretakers, etc.?
Why, then, would anyone even want to have a free market? Honestly, I do not know much of anything on this subject, but why are there so many people more interested in profits than other’s well-being who otherwise couldn’t help it? It is like having the entire world all to yourself, but just because you have it, all means nothing when there is no one to share it with. So what is the point, or so enjoyable, in taking, taking, taking, while also watching people around you suffer, starve, and die, merely for not having a way to EARN money, nor receive help in retirement age, or as someone injured into a life-long disability, or born with one? It truly does seem ruthless, in my opinion. I looked this up because it is in a running senator’s political policies, who I thought of voting for until I read this. After all, I was wondering why it was mentioned so much. Now I see why there are only 23,000 people who voted for them. I know this is from 2011, and it is now 2020, but I hope you will respond or email me about this. Thank you!
Many Blessings,
Lush
Lush,
Its minimum wage laws that make it impossible for disadvantaged people to get work.
Remove minimum wage and these people can gain experience in work that they are capable of.
Everybody has some skill or service to offer. They just need the right price
Matt
A race to the bottom? That’s been happening, in earnest, since the early 80’s, when Reagan and his Libertarian cronies took hold.
How’s that working out? Less and less middle class with every passing day.
Disadvantage
There will be a great margin of difference between the rich and the poor
Production of harmful products
Why is it that in a free market economy all consumers have equal chance of determining what is produced
well not the equal chance, it relates to the demand of the product. if the market(sellers) sells the product (to consumer) in more quantity and at a reasonable/demanded price, then the producer will produce and distribute the products in that amount. for e.g: Pepsi cans are short in a superstore and people are demanding pepsi cans then the super store will contact Pepsi to deliver the cans as the 50-100 people are demanding it. that is one way demand of the product can be analyzed.
thank you 🙂
Happy quarantine
Demerit goods are mostly demanded and profitable in a market economy and not much people value education especially in rural areas so they won’t be produced.Other services like electricity cannot be produced by individuals, just imagine if anyone can start an electricity firm and they will be so many cables in the air which is disastrous.so government got to intervene somehow✅
Why in a free market economy, consumers do not have equal chance in determining what is produce
what are some examples of free market?
Singapore is a good example.
Great article!
Do you personally think the disadvantages disqualify “free market utopias” as advertised by libertarians or the like?
I can squash all 4 disadvantages
1. A business with poor quality products will be marketed out of business. Everybody who has actually ran a business knows its cheaper to maintain good customers/clients than it is to find new ones.
2. Rural communities will be able to provide goods and services to each other which keeps profits within the community. Haven’t you noticed rural communities suffer more with bigger government.
3. Companies out pricing smaller competitors is on the back of chrony capitalism. When these companies have an bottomless bucket due to central banks printing fiat, they can trade at a loss until competitors fall out. Free markets keep companies honest with profit and loss.
4. Unemployment is caused by minimum wage increases, unskilled employees get priced out. Removing minimum wage allows these workers to gain skills and experience and be able to charge more for their own services in the future.
Matt
But that “unseen hand” that “corrects” all of unfettered, free-market Capitalism’s faults, moves very very slow. Practically nonexistent in today’s environment.
Is that free market good or bad, why. Where we want to choose to do sale, (free market or market {ordinary})?
How do you expect them to make enough to live if they are payed ‘the right price’ aka close to nothing since as stated in the article we all read, profit incentive without regulation breeds exploitation. If capitalism was run with just a shred of sanity, Minimum wage would keep up with 1. Inflation and 2. Worker productivity at the very least! But instead we have gaslit working class such as yourself (I’m assuming) believing the lies told to them by their corporate oligarchs and working against their own self-interests! Not only is Capitalism irrational as a mode of production with which we survive, it rewards irrationality. Why would you ever want to stick with a system that is, to put it simply, insane? This problem effects every creature including humans, across the globe. It’s no longer about ‘opinions’ or ‘political views’, it is a question of whether we can change our mode of production with which we survive, and thus thrive. We’ve let it get to the point where it’s do or die for the working class, thanks to the climate crisis (do as in changing our system from capitalism)
So, make your choice. Future generations will know your answer.
The rule of market, in the end, is still a mortal rule, not one imparted with divine infallibility. If political powers can be abused to the interest of a minority, the power of market can also lead to dictatorship, albeit an economic one. It is common sense that political powers should be held in check through intricate divisions of power, yet the power of the market is somehow given carte blanche. Dubious, to say the least, in trusting the market so much.
“4. Unemployment and Inequality”
This should in no way be listed as a negative and should actually be a positive
There will be inequality and unemployment regardless of the economic system that you use. Free market societies might look like they have the most disparity between rich and poor but it’s a mistake to look at it that way. In a free market society the overwhelming majority are lifted out of poverty and socialistic systems are nearly always put in place by the governing body to catch those who fall through the cracks. In EVERY socialist society the reason why there seems to be no economic disparity is because everyone is starving equally except the ones in power. The working class are worked to death to produce nothing they are allowed to own and only those who are representatives of the main body of authority have any power.
Even in non free market societies, the minority few hold all the power and wealth. The difference is that MOST are at the bottom and the bottom is slavery.
“Examples of harmful effects of unethical cost reduction measures include polluting the environment or exploiting (overworking, under-paying, preventing workers from unionizing etc.) workers. Government intervention is necessary to limit these harms.”
Ironically, these effects can only manifest in government regulated economies. In free and competitive markets they are not possible. I.e. worker exploitation is not possible if a worker can simply quit a bad job and go to an employer with a better offer. Very much like a consumer is not obliged to buy a bad product and can always get the price and quality he wants from a different supplier.
Environmental pollution will result in damage and health claims for the polluter. A proper justice system will deal with these and prevent future damages.
If the environment is not private property but public property, or even no ones property, the justice system will not work efficiently enough to prevent all damages. This is usually the case when government protects against environmental pollution.
“Goods and services that are not profitable will not be produced or run. Rural communities will suffer as a result. Examples include transportation and postal services, as well as rural hospitals, which are necessary despite the fact that they may not be profitable to run. In such cases, the government must provide these goods and services so that people do not go with their basic needs unmet.”
In a free market goods and services will always be produced if there is a demand. If current options are to expensive innovative entrepreneurs will offer less expensive options. A textbook example is transportation a century ago. At that time cars were handbuild in very small numbers at the cost of a house. Henry Ford changed that by introducing assembly line mass production. This lowered the price of a car tenfold. People that were never before able to buy a car now could afford one.
“The large-scale companies with greater capital and labor resources can beat out smaller companies simply for their size alone, rather than for the quality of their product; if this process continues, they may eventually gain a monopoly over their market.”
In a free market monopolies or cartels cannot exist for long if their offer does not match market demand. I.e. if a cartel maximizes profit margin and has a very high retail price, because of lack of competition, the large profit margin attracts many new suppliers. This requires the cartel to lower their price to compete. But then the market share and thus the total profit of an individual cartel member decreases too. The only way a member can increase market share again is by leaving the cartel and competing on its own.
A large monopolist will offer a high retail price, low quality and low service level for maximum profit. The high profit margin will also attract many new suppliers. Their market entrance will force the monopolist to lower its price. Because of its economies of scale it can always compete at the lowest price levels. This is good for its customers because these now pay a much lower price than before. Then the monopolist needs to compete on quality and service level as well. Otherwise the new suppliers will be able to compete at a higher price level offering better quality and better service. Most monopolists cannot offer the best possible quality and service at the lowest possible price. Eventually the market will have a mix of offerings, servicing the customers in the best possible way.
“In a free market economy, certain members of society will not be able to work, such as the elderly, children, or others who are unemployed because their skills are not marketable. They will be left behind by the economy at large and, without any income, will fall into poverty. Their caretakers will also be left out of the economy, because they will not be paid for their necessary caretaking work.”
Every individual has marketable skills. Even the late physicist Stephen Hawking, who was paralyzed from the neck, wrote books and gave lectures. All over the world people were willing to pay for Hawking’s knowledge and ideas. Small children are the responsibility of their parents. If a couple is expecting it is wise for them to insure heir child against disability. And adults should insure themselves against unemployment. It is not necessary for a government to intervene and to offer social security. The free market can offer that just as well or even better.
Good afternoon,
Please, Does free market healthcare increase innovation in the production of medicines??