Globally, economies are characterized by their features and categorized into different systems, structures, and classes. There are a variety of economic systems, such as capitalism and communism. There is also a range of economic structures, ranging from one extreme of a command economy to the other extreme, a free market economy.
In this piece of writing, we delve into the free market economy to better understand what it means and how it operates. We first define a free market economy and then identify the characteristics of this type of economy that differentiate it from other economic structures. After this, we list real-world examples of free-market structures. This is followed by the advantages and disadvantages of the system.
To begin, let us define what a free market economy is.
Definition of a Free Market Economy
A free-market economy is an economic structure that depends on the private sector and the self-motivated incentives of private individuals for the management, provision, production, and distribution of economic resources. This type of economic structure limits how much control a government has over privately-owned economic resources. Therefore, it is preferred that the government has minimal to no intervention over economic activity and that the main economic role-players and influencers should be individuals.
This economic structure is sometimes referred to as a “laissez-faire” system. Laissez-faire is a French term that means “leave them to do.” This ties into the free market economic system, which beliefs in letting people do as they please in their economic decisions. One of the most distinctive features of the free market economic structure is how there are no constrictions on individuals’ economic decisions.
The free market economy argument insists that all individuals are self-interested. This leads them to naturally seek out things that will help them satisfy their own desires and needs. In addition to this, this creates an opportunity for those who possess what others want, where they can sell or exchange the wanted goods for money. This happens in a cyclical and ongoing manner, creating a market environment where private individuals freely exchange products and services at an agreed cost.
Having property rights is important in this structure as it helps organize and allocate resources among the individuals who own them. This, however, creates room for unequal wealth and income distribution as individuals will unlikely possess equal amounts or rights to ownership over available productive resources. However, the free market economy believes this type of market should not be interfered with. It may destroy the natural balance of economic activity, which is believed to be optimal and well-balanced. This natural self-regulating economic activity is referred to as the “invisible hand.”
We will now further explore the characteristics of a free market economy.
Characteristics of a Free Market Economy
The following are five key characteristics of a free market economy:
- Role of The Government. The government in a free market economy is discouraged from intervening in private market operations. Government intervention and control are viewed as undesirable and unnecessary under such an economic structure. The input of a government can be seen as disruptive and as a disturbance to the natural order of market behavior. In some cases, government intervention is argued even to worsen an existing irregularity. The government’s role in this type of economy may be reduced to the provision of essential goods or services. This structure relies on a relatively decentralized approach and requires the government to take a “back-seat” role and let everyone do as they deem fit.
- Innovation and Voluntary Economic Participation. The free market economy breeds a lot of room for innovation because producers will be in heavy competition and, therefore, have to always look for ways to stand out and improve their products. Private entities also have the freedom to produce new goods or services at their own will. This dynamic promotes the production of quality goods.
- Supply and Demand. A free-market economy’s supply and demand characteristics allow the invisible forces of demand and supply to regulate and determine prices and quantities produced and sold in a given market for a product or service. Supply exhibits the number of products that suppliers, producers, service providers, and resource owners are willing to sell at a given price and time. Demand shows the number of products or services that buyers, consumers, and customers are willing to purchase at a given price and time. Together, the two forces are dependent on one another to determine the market price and quantity of output that best represent market behavior, wants, and needs. In the free market economy, the forces of supply and demand are left alone without substantial intervention to regulate the market. Under this economic structure, it is believed that the market forces are self-regulating and lead to the most optimal economic performance if left without any interference.
- The Self-Regulating Mechanisms. As established, free-market economies uphold the belief that market forces are naturally self-correcting and can adjust if any irregularities. This is supported by the argument of supply and demand, which automatically reflect market needs and behavior. Another way free-market economies are self-regulating is the belief that private households and individuals have to balance out economic activity through their instinctive behavior and reactions. Thus, if there is an irregularity in the market, it is believed that private individual actions will correct the irregularity.
- Ownership of Resources. A free-market economy is an economy that has its productive resources in the hands of private individuals or entities. These resources are also referred to as factors of production as they are key inputs that help produce desired products and services. The government can only own a relatively small portion of these economic resources compared to the private sector, which is expected to have dominant control over the resources.
Following this are several countries that display free-market economy characteristics in the real world.
Real-World Examples of a Free Market Economy
It is important to note that a purely free-market economy does not actually exist in this world of ours. Still, some countries cater very closely to the requirements of a free market economy. The following are examples of countries that perform in a manner that is relatively similar to free-market economy ideals: Hong Kong, the United States of America, Ireland, Singapore. Canada, Australia, New Zealand, China, Germany, Italy, Russia, Norway, Switzerland, Lithuania, Finland, Malaysia, India, France, Denmark, Taiwan, Netherlands, Japan, Chile, and the United Kingdom.
Now we will look into the advantages and disadvantages of a free market economy.
Advantages of a Free Market Economy
- There is an incentive for innovation because producers feel the need to make their products and services stand out.
- Customers have the power to influence the kind of products that are produced and sold because of their tastes, reactions, and behavior.
- There tends to be high competition because many are motivated to fulfill their self-interests by providing goods and services for profits. This leads to market-friendly prices, leaving consumers financially better off.
- There is a high provision of a variety of products which expands consumer choices regarding their purchases.
- Products and services are likely to be of good quality because suppliers and producers are incentivized to provide durable, relevant, appealing, and useful products to the market in order to succeed.
- There are low or no barriers to entry, making it easy for new entrants to build businesses.
Disadvantages of a Free Market Economy
- Because there is no large government intervention, consumers and other producers have minimal protection from predatory business behavior or even the formation of monopolies.
- Resource degradation is at high risk because the users are individuals who are most likely to be driven by their self-interest and profit goals. These incentives could lead to the misuse, destruction, and eventual depletion of available resources, especially non-renewable resources.
- Because of the lack of government regulations, environmental concerns may not be adequately or appropriately addressed especially where production leads to high amounts of pollution.
- Free market systems may also lead to little to no production of certain goods or services that are beneficial for the public interest if the private sector finds them unprofitable.
- Lack of government intervention may also lead to market failures that lead to negative externalities and the destabilization of the economy.
- The profit motive may also lead to the social exclusion of groups of people who do not have many productive resources or financial means.
Other Economic Structures
The free market economy is one of four commonly identified economic structures. The four economic structures are defined and distinguished by the way resources are organized in an economy and the power that different economic players have when making economic decisions and reallocating factors of production. Since we have already addressed the free-market economic structure, the remaining three are defined as follows:
- The Command Economy (Planned Economy)
The free market structure of an economy is completely different from a command economy. The command economy is also known as a planned economy. This economic structure places the factors of production, productive resources, and influential power over the market in the hands of the government. Production, distribution, and resource allocation are fully regulated according to the main authoritative figure’s decisions. Unlike a free market economy, there is more government regulation and less freedom for private entities to perform economic activities in any way they see fit. The government plays a very dominant and active role in how economies operate and directly oversee the allocation and management of economic resources. The command economic structure can be commonly found in communist economies.
- The Subsistence Economy (Traditional Economy)
The subsistence economic structure, also coined as a traditional economic structure, bases a lot of its economic activity around domestically produced goods and services. This economic structure tends to be in place in societies that mainly practice agricultural or traditional economic activity. Economies with such an economic structure tend to be prominent with rural areas where agrarian activities are still a driving force of income. It has been described as a relatively aged structure that is not common in more developed countries. Though it promotes sustainable practices and economic activities, it is not as progressive as the other economic structures.
- The Mixed Economy (Dual Economy)
A mixed economy, also known as a dual economy, possesses features that apply to both the free market economy and the command economy. In some cases, the subsistence economy’s features can also be found in a mixed economy. There is no specific balance or mix that defines a mixed economy. As long as it exhibits the characteristics of more than one economic structure, it qualifies as a mixed economy. A mixed economy allows private entities to exercise a level of economic freedom regarding how they choose to handle productive resources. At the same time, it grants the government the authority to impose regulations over market activity and intervene in the market activity where it believes action is necessary. The same economy may have a rural sector that heavily depends on an agrarian lifestyle and economic activity. Therefore, a mixed economy can embody varying mixtures of the different economic structures. Most countries in the modern world carry a mixed economic structure. It is difficult to find countries that purely fall into one economic structure.
As established, a free market economy lies on one extreme of the spectrum on how economies are structured in the real world. Most countries in real life actually embody a mix of free-market and command economy characteristics. The more regulations and intervention a market faces, the lesser its weight is a free market economy. Conversely, the less the restrictions are on economic activity, the more an economic structure can be considered a free-market economy.
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