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Edith Forsyth has taught High School Business for over five years. They have a bachelor’s degree in business administration from University of Evansville, Evansville, Indiana.
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Learn about free markets. Understand what a free market is, learn how a free market system works, identify the pros and cons of free markets, and see examples.Updated: 11/21/2023
Table of Contents
- What is a Free Market?
- Free Market Economy Examples
- Lesson Summary
Frequently Asked Questions
What are free markets in economics?
In economics, free markets are economic systems characterized by limited government intervention. In these markets, prices are subject to the law of supply and demand.
What is an example of a free market?
Free markets are characterized by limited government control. An example is a tour company that is free to choose its prefered destinations, target market, and pricing strategy.
Table of Contents
- What is a Free Market?
- Free Market Economy Examples
- Lesson Summary
One of the many existing economic systems is the free market. Eighteenth-century Scottish philosopher, Adam Smith, considered to be the ''father of modern economics,'' advocated for market-determined wages and provided the free market definition. He postulated that a free market is possible when there is limited government control with the interplay of supply and demand determining the flow of products in the market. Here, product prices depend on prevailing market forces. In such a market, there are no barriers to agents. For instance, a seller is free to trade at any time and price.
The following are the main characteristics of a free market economy:
- Resources are privately owned. A free market exists because people own resources they sell to others. The owners have complete control of their resources, which gives them the power to enter into contracts. The government does not control how resources are allocated or exchanged in the economy.
- Financial markets are necessary for the existence of a free market. The presence of these institutions is critical because it provides the means of exchanging products.
- People are free to participate in the economy. There are no barriers that prohibit people from participating in the economy. Essentially, people enter into contracts freely. In that case, sellers or buyers can sell or purchase as many products as they want.
- People are driven by self-interest. Sellers provide products in the market depending on their needs. For instance, they supply products in the market, aiming to make the highest possible profit.
- Competition limits the power of agents. A seller does not engage in unethical activities, in order to avoid tarnishing the brand name. Sellers lower the prices to attract customers. When the supply is low, consumers compete for the products.
Free Market Systems
A free market economy can only be successful in the presence of certain key assumptions. The following are the main assumptions of a free market system:
- Consumers and sellers want to satisfy their needs and pursue their individual interests. Sellers and buyers participate in a market because they desire to meet their needs or interests.
- The role of the government is limited. Presumably, the government does not have control over a free market. Instead, it focuses on providing security, laws, and policies.
- Sellers and buyers have access to complete information. Agents can access information at any time. For instance, sellers have access to information regarding the purchasing habits of customers and the business practices of their competition. They are aware of the quantity and quality of supply in the market.
- There are many sellers and buyers in a free market. If one of the sellers does not meet the expected standards, another will enter the market. Because of many customers, sellers can find those interested in their specific products. If the price is competitive, a seller can attract consumers.
- Producers are free to produce and supply products in the market, while consumers can buy any product from any producer.
- The law of supply and demand determines market prices, thus ensuring balance in the economy.
- The rights of sellers and buyers include access to information and the freedom to produce, consume, and make decisions. Access to information gives producers and consumers the freedom to make production, distribution, and purchasing decisions. Sellers have a right to adjust prices to match the demand for their products. Since the government does not constrain producers and consumers, the participants are free to establish contractual agreements.
Advantages and Disadvantages of a Free Market
A free market has several advantages and disadvantages. The following are the advantages of a free market:
- Resources are efficiently allocated. The suppliers know when to increase or decrease prices. As such, businesses adapt accordingly, preventing inefficiencies.
- A free market encourages competition. The government does not set regulations, making it easier for firms to enter or exit the market. The absence of quotas and tariffs creates an opportunity for competition. Also, the entry of new companies exerts pressure on existing businesses, ensuring an increase in the quality of goods and services.
- There is innovation and economic growth. Sellers are driven by the need to generate profit. As a result, they create new techniques of production. In so doing, they increase efficiency by reducing the cost of production.
- Consumers are provided with many alternatives because the government does not restrict markets, allowing businesses from different countries to enter. This results in a variety of products in the market. Consumers are allowed to decide where they will spend their money.
- Business owners are free to choose their hours of operation, business terms, prices, policies, and products or services to offer.
Nonetheless, free markets have several shortcomings. The following are disadvantages of a free market:
- Natural monopolies emerge, making it hard for other businesses to enter the market. For instance, a sewer company can dominate the market. This eliminates the chance of new companies entering the market.
- It results in a lack of public goods. The government does not provide public goods. Unfortunately, the private sector cannot offer these products at lower prices because of the high cost of production.
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In the real world, a pure free market economy does not exist. However, the economies of the following nations can help illustrate the nature of free markets.
- The USA can be considered a free market economy. Sellers are free to produce whatever they want. As a result, many high-tech companies have mushroomed. However, the government creates regulations to control company operations. Nonetheless, companies are free to introduce new products into the market, set prices, and compete.
- In Singapore, producers are free to enter the market. The government does not control their production activities, and companies are not required to pay high taxes to the government.
- Macedonia has created conducive conditions that promote a free market. Business owners are eligible to apply for citizenship if they employ Macedonians. Overall, the government has limited control of business operations.
Examples of free market enterprise include the following:
- Retail outlets that decide what types of products to sell, where to locate their stores, and the price for their products.
- A manufacturing company that decides when to offer new products, expands its current portfolio, and when to target new customers.
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A free market is an economic system where the law of supply and demand determines market prices. There is limited government regulation in this market. The government's role is limited to providing security, laws, and policies. A free market is characterized by privately owned resources, financial institutions, the freedom to participate, self-interest, and competition. Advantages of this market system include efficient resource allocation, competition, innovation, and product variety. Sellers in a free market have a right to adjust prices to match the demand for their products. Further, consumers are allowed to decide where they will spend their money. Business owners can choose their hours of operation, business terms, prices, policies, and products or services.
However, a free market also has several drawbacks, such as creating natural monopolies and the lack of availability of public goods. Some examples of free market enterprises include the following:
- Retail outlets that decide what types of products to sell, where to locate their stores, and the price for their products.
- A manufacturing company that decides when to offer new products, expands its current portfolio, and when to target new customers.
The USA is an excellent real-world example of a free market economy where businesses are not restricted in their production or innovation. Therefore, many companies have created multiple products to meet consumers' needs. Macedonia and Singapore are two other countries that have created conditions for promoting a free market. These countries have limited regulations that burden business operations.
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Video Transcript
What Is a Free Market?
A free market is an economic system that is created by interactions between buyers and sellers that have few, if any, regulations. Sellers can determine at what price they'll sell products or services and the buyers have the choice of whether or not they want to spend that amount. In a free market, there is a constant give-and-take between buyers and sellers. Sellers can easily respond to buyer preferences by lowering or increasing their prices based on demand. If demand for a product goes up, a seller has the right to raise prices to capitalize on the additional earnings from increasing the prices. Likewise, if the demand goes down, sellers have the right to lower the price of their products to encourage more people to buy them.
Advantages of a Free Market
The biggest advantage of a free market is the flexibility both the buyer and seller have in how they interact. With little government regulation, buyers can spend their money however they choose. For this reason, they can make purchasing decisions based on what they need, want, and have the resources to purchase. They also have the right to choose who they'll purchase items from.
Here's an example:
Fred owns a flower shop and imports exotic flowers from around the world. His selection is unique and beautiful. However, his prices are considerably higher than any other flower shop in the area, and the prices fluctuate almost daily based on what flowers he has in stock and the availability of flowers from his vendors. Recently, he's been able to secure new vendors that offer much better prices. Fred has the right to choose to pass those savings on to his customers, offering them lower prices on their flowers, or he may choose to keep the extra earnings for himself. As part of the free market system, Fred has the right to make these decisions for himself.
Now imagine that you're in need of flowers and want something really special and maybe even unusual. You go to Fred's shop to find an exceptional arrangement of flowers, knowing that Fred offers a much wider selection of flowers than any other shop in your town. When you arrive at the shop, you find the perfect arrangement of flowers from the other side of the world. You notice the price is quite high - more than three times what a typical arrangement of flowers would cost! As a member of the free market system, you have the right to choose to buy the more expensive flowers or go to another flower shop and get a less expensive arrangement. But that arrangement might not have what you're looking for. That's part of the give-and-take of a free market system!
Examples of a Free Market
In America, most companies participate in the free market system and are allowed freedom in how they operate their business. They can choose the hours they operate, the policies and terms of their business, and what products or services they'll offer. The business owners can set prices based on what their expenses are and what consumers are willing to pay.
Here are a few examples to think about:
- Restaurant owners can decide what types of foods they'll offer, where they'll run their business, and what they'll charge for their meals.
- Plumbers can decide what services they want to offer their customers, where they are willing to travel, and how much their services will cost.
- A greeting card company has decided to offer a new line of gifts that allow customers to personally record their message on a recordable device found in a variety of stuffed animals. As part of the free market system, the company is allowed to offer new products, expand its current business, and sell to new customers who are interested in stuffed animals with a personal greeting.
Lesson Summary
A free market offers flexibility and options to both consumers and business owners. It allows buyers and sellers to find a beneficial meeting point. Consumers are allowed to decide how and where they'll spend their money. Business owners are allowed to set their own prices and offer products and services of their choice. Successful business owners respond to their customers' preferences by offering products at prices that match what their customers want and are willing to spend.
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