What is a Free Market?
A free market is a system in which the prices for goods and services are self-regulated by the open market and by consumers. In a free market, the laws and forces of supply and demand are free from any intervention by a government or other authority, and from all forms of economic privilege, monopolies and artificial scarcities.
Proponents of the concept of free market contrast it with a regulated market in which a government intervenes in supply and demand through various methods such as tariffs used to restrict trade and to protect the local economy. In an idealized free-market economy, prices for goods and services are set freely by the forces of supply and demand and are allowed to reach their point of equilibrium without intervention by government policy.
A free market is an unregulated system of economic exchange in which taxes, quality controls, quotas, tariffs, and other forms of centralized economic interventions by government either do not exist or are minimal. As the free market represents a benchmark that does not actually exist, modern societies can only approach or approximate this ideal of efficient resource allocation and can be described along a spectrum ranging from low to high amounts of regulation.
Understanding Free Market
The term “free market” is sometimes used as a synonym for laissez-faire capitalism. When most people discuss the “free market,” they mean an economy with unobstructed competition and only private transactions between buyers and sellers. However, a more inclusive definition should include any voluntary economic activity so long as it is not controlled by coercive central authorities.
Using this description, laissez-faire capitalism and voluntary socialism are each examples of a free market, even though the latter includes common ownership of the means of production. The critical feature is the absence of coercive impositions or restrictions regarding economic activity. Coercion may only take place in a free market by prior mutual agreement in a voluntary contract, such as contractual remedies enforced by tort law.
Free markets are related to capitalist nations because the economic freedom is a key feature of capitalism. Protection to private property and rights are conditions to guarantee a proper performance of free markets. Since market forces ultimately drive decisions, this is the system that guarantees higher efficiency and lower prices. In this regard, quantities and prices are self-regulated by supply and demand.
Nevertheless, no country in the world offers absolute economic freedom. Market imperfections always exists and those cannot be self-controlled by the market. Situations such as information asymmetry, extremely few sellers or buyers and high entry or exit barriers cause the intervention of the government with the aim of regulating damages to certain economic agents. Even in the U.S., which is a country considered to enforce a free market ideology, the government imposes regulations to correct or diminish market imperfections. An extremely regulated market is the opposite of a free market.
Many economists consider resource allocation in a free market to be Pareto-efficient, where no one can be made better off without making other individuals worse off, given certain conditions (like the absence of externalities, or side effects, and of informational asymmetries, or disparities of knowledge, among others). Moreover, according to this theory, through the invisible-hand mechanism of self-regulating behaviour, society benefits by having self-interested actors make free economic decisions that benefit themselves. Some ethicists have argued that the efficiency of free markets depends on several moral parameters as scope conditions, such as fair play, prudence, self-restraint, competition among equal parties, and cooperation.
Critics of the free market system tend to argue that certain market failures require government intervention.
First, prices may not fully reflect the costs or benefits of certain goods or services, especially costs to the environment. Public goods are often underinvested or exploited to the detriment of others or future generations, unless such exploitation is prohibited through government regulation.
Second, a free market may tempt competitors to collude, which makes antitrust legislation necessary. Antitrust and similar regulations are especially necessary in cases where certain market actors, such as companies, have acquired enormous market power.
Third, transaction costs may mean that some exchanges are best performed in a hierarchy rather than in spot markets (where payment and delivery are made on the spot). Most importantly, Pareto-optimal resource allocation in a free market may violate principles of distributive justice and fairness and may thus necessitate some government action.
Characteristics of a Free Market
A free market economy is characterized by the following:
1. Private ownership of resources
Free economies exist because a significant portion of resources are owned by individuals or companies in the private sector and not a central government agency. In this way, the owners exercise total control over the means of production, allocation, and exchange of products. They also control the labor supply.
2. Thriving financial markets
One key factor that helps a free market economy to be successful is the presence of financial institutions. Banks and brokerages exist so that they give individuals and companies the means to exchange goods and services, and to provide investment services. The financial institutions then make a profit by charging interest or fees on transactions.
3. Freedom to participate
Another characteristic of a free market economy is that any one individual can take part in it. The decision to produce or consume a particular product is totally voluntary. It means that companies or individuals can produce or purchase as much or as little of a product as they want.
Benefits of a Free Market
The absence of governmental influence allows both companies and individuals a wide range of freedom.
1. Freedom to innovate
In a free market economy, business owners enjoy the freedom to come up with new ideas based on the consumers’ needs. They can create new products and offer new services at any time they want to. As such, entrepreneurs rarely rely on government agencies to notify them of consumers’ needs.
The entrepreneurs do their own research and identify popular trends. The innovation among different private companies can lead to competition as every company tries to improve on the features of its products to make them better.
2. Customers drive choices
With a free market economic system, it is the consumers who decide which products become a success and which ones fail. When presented with two options of products, the consumer evaluates the features of each and chooses whichever one they want to, ideally opting for the one that offers better value for money.
To a great extent, the consumer also influences the price set on a product. As such, producers need to strike a balance between the price point that earns them a profit but is still affordable by the average customer.
Drawbacks of a Free Market
Despite its benefits, a free economy also comes with a few drawbacks:
1. Dangers of profit motives
One disadvantage of a free market economy is that some producers are driven exclusively by their profit motives. Even though the primary goal of any business is to generate profit, such an objective should not be prioritized over the needs of workers and consumers. Put simply, a company should never compromise the safety of its workers or disregard environmental standards and ethical conduct just so it can make supernormal profits.
An example took place in the early 2000s, a time when unethical behavior became prevalent among companies such as WorldCom and Enron. In 2010, the Deepwater Horizon oil spill, which is one of the biggest environmental disasters in the United States, happened because the company used substandard cement and other cost-reducing measures.
2. Market failures
At times, a free market economy can spin out of control, causing dire consequences. Good examples of market failure include the Great Depression of the 1930s and the real estate market crash that happened in 2008. Market failures can lead to devastating outcomes such as unemployment, homelessness, and lost income.