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Free Market

A type of economic system that is controlled by the market forces of supply and demand

What is a Free Market?

A free market is a type of economic system that is controlled by the market forces of supply and demand as opposed to government controls that involve price-cutting monopolies. It is different from a regulated market or command economy. In the latter, a central government agency decides the supply and demand, which means the market does not operate freely. In a free market, a majority of companies and properties are owned by individuals or entities in the private sector instead of the state.

 

Free Market

 

Understanding the Free Market Economy

Economists define a free market as one where products are exchanged by a willing buyer and seller. Purchasing groceries at a given price set by the farm grower is a good example of economic exchange. Paying a worker a monthly salary is another instance where an economic exchange happens.

In a free or pure market economy, sellers of different goods don’t face any barriers. Essentially, one can sell any product they wish to sell and at any price. However, in the real world, such a kind of economic system rarely exists. Tariffs imposed on imports and exports and legal restrictions such as the age restriction on alcoholic beverages are all barriers to a free market.

Overall, capitalist economies, which are practiced by most democracies, including the United States, are free only because ownership belongs to a few individuals as opposed to the government.

 

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 is 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. 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 as much or as little of a product as they want.

 

Benefits of a Free Market

The absence of governmental influence allows companies a wide range of freedom.

 

1. Freedom to innovate

In a free market economy, business owners enjoy all 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 product to make it 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 goes 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 that 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.

 

Summary

A free market is a self-regulated economy that runs on the basis of demand and supply. In a truly free market, the central government agency does not regulate any aspect of the economy. By removing government regulations, the nature of the free market forces businesses to provide superior products and services that address consumers’ needs. A free market economic system also helps sellers to create affordable prices for everyone.

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Keynesian Multiplier
  • Laissez-faire
  • Reaganomics
  • Socialism vs. Capitalism

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