The Free Market System Essay

Free market economic system

The free market means that economic decisions are taken by private individuals and firms. Everything is owned and operated by private individuals. In a pure free market there would be no government intervention in the economy. However, in practise governments usually involve themselves in the implementation of certain laws and certain public services, even if only national defence and the protection of private property.. We often speak about America having a free market economy because most businesses are left to private enterprise. But, even in America the government spends about 35% of GDP.

Theoretical support for a free market was strongly supported by Adam Smith in his book, 'The Wealth of Nations'. The wealth of nations tried to explain that; when people try to maximise their individual utility it actually leads to the best outcome for the rest of society.

However, Adam Smith was aware of some limitations of the free market. For example, he was aware of how monopoly power could be abused. But, basically his theories crystallised the theoretical underpinnings of a free market approach. Many of his arguments remain relevant today.

Benefits of a free market

  • Firms have incentives to be efficient and provide goods and services demanded by consumers
  • It avoids the bureaucracy often involved in government intervention.
  • The profit motive provides an incentive to cut costs and make efficient use of scarce resources
  • Economic freedom is important for personal freedom.

Problems of a Free Market
"Capitalism is the astounding belief that the most wickedest of men, will do the most wickedest of things for the greatest good of everyone."
- John Maynard Keynes, as quoted in Moving Forward: Programme for a Participatory Economy (2000)
A free market has various problems. This is a silly mnemonic to help you remember them. PIMM FACED.

P - Public Goods are not provided in a free market. A public good is a good with the characteristics of non rivalry and non excludability. Examples include street lighting and national defence.

I - Inequality. A free market provides no social security net for those who are unemployed or on low income. Furthermore the nature of a free market is that the benefits tend to accrue to a small number of people who have the advantage of property and monopoly power

M - Monopoly. In an unchecked free market, monopolies can easily develop. This means the owners are in a position to set high prices and exploit both consumers and workers.

M - Merit Good - Education and health care. Under-provided because people underestimate the benefits of going to school e.t.c.

F - Factor immobility. Geographical unemployment. Occupational unemployment through lack of skills

A - Agriculture. - Agriculture is prone to market failure e.g. weather can harm crops

C - Cyclical Instability - economic recessions and the corresponding unemployment

E - Externalities - Over-consumption of goods like tobacco with negative externalities

D - De merit goods - Overconsumption of goods like alcohol, where people overestimate the personal benefits, underestimate the costs of getting drunk.

Related pages

A market economy is an economic system in which the decisions regarding investment, production, and distribution are guided by the price signals created by the forces of supply and demand. The major characteristic of a market economy is the existence of factor markets that play a dominant role in the allocation of capital and the factors of production.[1][2]

Market economies range from minimally regulated “free market” systems to interventionist forms, where the government plays an active role in correcting market failures and promoting social welfare. State-directed or dirigist economies are those, where the state plays a directive role in guiding the overall development of the market through industrial policies or indicative planning — which guides but does not substitute the market for economic planning — a form sometimes referred to as a mixed economy.[3][4][5]

Market economies are contrasted with planned economies where investment and production decisions are embodied in an integrated economy-wide economic plan by a single organizational body that owns and operates the economy’s means of production.


Supply and demand[edit]

Market economies rely upon a price system to signal market actors to adjust production and investment. Price formation relies on the interaction of supply and demand to reach or approximate an equilibrium where unit price for a particular good or service is at a point where the quantity demanded equals the quantity supplied.

Governments can intervene by establishing price ceilings or price floors in specific markets (such as minimum wage laws in the labor market), or use fiscal policy to discourage certain consumer behavior or to address market externalities generated by certain transactions (Pigovian taxes). Different perspectives exist on the role of government in both regulating and guiding market economies, and in addressing social inequalities produced by markets. However, fundamentally a market economy requires that a price system affected by supply and demand exists as the fundamental mechanism for allocating resources irrespective of the level of regulation.

Property rights[edit]

For market economies to function efficiently, governments must establish clearly defined and enforceable property rights for assets and capital goods.

However market economies do not logically presuppose the existence of private ownership of the means of production. Market economies can and often do include various types of cooperatives or autonomous state-owned enterprises that acquire capital goods and raw materials through capital markets. These enterprises utilize a market-determined free price system to allocate capital goods and labor.[6] In addition, there are many variations of market socialism, some of which involve employee-owned enterprises based on self-management; as well as models that involve the combination of public ownership of the means of production with factor markets.[7]


Main article: Capitalism

Capitalism generally refers to an economic system where the means of production are largely or entirely privately owned and operated for a profit, structured on the process of capital accumulation. In general, in capitalist systems investment, distribution, income, and prices are determined by markets, whether regulated or unregulated.

There are different variations of capitalism with different relationships to markets. In Laissez-faire and free market variations of capitalism, markets are utilized most extensively with minimal or no state intervention and regulation over prices and the supply of goods and services. In interventionist, welfare capitalism and mixed economies, markets continue to play a dominant role but are regulated to some extent by government in order to correct market failures or to promote social welfare. In state capitalist systems, markets are relied upon the least, with the state relying heavily on either indirect economic planning and/or state-owned enterprises to accumulate capital.

Capitalism has been dominant in the Western world since the end of feudalism, but most feel[who?] that the term "mixed economies" more precisely describes most contemporary economies, due to their containing both private-owned and state-owned enterprises. In capitalism, prices determine the demand-supply scale. For example, higher demand for certain goods and services lead to higher prices and lower demand for certain goods lead to lower prices.


Main articles: Laissez-faire and Economic liberalism

Laissez-faire is synonymous with what was referred to as strict capitalistfree market economy during the early and mid-19th century[citation needed] as a classical liberal (right-libertarian) ideal to achieve. It is generally understood that the necessary components for the functioning of an idealized free market include the complete absence of government regulation, subsidies, artificial price pressures, and government-granted monopolies (usually classified as coercive monopoly by free market advocates) and no taxes or tariffs other than what is necessary for the government to provide protection from coercion and theft, maintaining peace and property rights, and providing for basic public goods. Right-libertarian advocates of anarcho-capitalism see the state as morally illegitimate and economically unnecessary and destructive.

Free-market economy[edit]

See also: Free market

Free-market economy refers to an economic system where 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. It typically entails support for highly competitive markets, private ownership of productive enterprises. Laissez-faire is a more extensive form of free-market economy where the role of the state is limited to protecting property rights.

Welfare capitalism[edit]

Main article: Welfare capitalism

Welfare capitalism refers to a capitalist economy that includes public policies favoring extensive provisions for social welfare services. The economic mechanism involves a free market and the predominance of privately owned enterprises in the economy, but public provision of universal welfare services aimed at enhancing individual autonomy and maximizing equality. Examples of contemporary welfare capitalism include the Nordic model of capitalism predominant in Northern Europe.[8]

Regional models[edit]

Anglo-Saxon model[edit]

Main article: Anglo-Saxon economy

Anglo-Saxon capitalism refers to the form of capitalism predominant in Anglophone countries and typified by the economy of the United States. It is contrasted with European models of capitalism such as the continental Social market model and the Nordic model. Anglo-Saxon capitalism refers to a macroeconomic policy regime and capital market structure common to the Anglophone economies. Among these characteristics are low rates of taxation, more open financial markets, lower labor market protections, and a less generous welfare state eschewing collective bargaining schemes found in the continental and northern European models of capitalism.[9]

East Asian model[edit]

Main article: East Asian model of capitalism

The East Asian model of capitalism involves a strong role for state investment, and in some instances involves state-owned enterprises. The state takes an active role in promoting economic development through subsidies, the facilitation of "national champions", and an export-based model of growth. The actual practice of this model varies by country. This designation has been applied to the economies of Singapore, Japan, Taiwan, South Korea and the People's Republic of China.

A related concept in political science is the developmental state.

Social market economy[edit]

Main article: Social market economy

This model was implemented by Alfred Müller-Armack and Ludwig Erhard after World War II in West Germany. The social market economic model (sometimes called "Rhine capitalism") is based upon the idea of realizing the benefits of a free market economy, especially economic performance and high supply of goods, while avoiding disadvantages such as market failure, destructive competition, concentration of economic power and the socially harmful effects of market processes. The aim of the social market economy is to realize greatest prosperity combined with best possible social security. One difference from the free market economy is that the state is not passive, but takes active regulatory measures.[10] The social policy objectives include employment, housing and education policies, as well as a socio-politically motivated balancing of the distribution of income growth. Characteristics of social market economies are a strong competition policy and a contractionary monetary policy. The philosophical background is Neoliberalism or Ordoliberalism[11]

Market socialism[edit]

Main article: Market socialism

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