We explain what the free market is, its characteristics, advantages and disadvantages. In addition, we tell you what market failures are.
What is the free market?
The free market or liberal market It is the economic exchange system in which the price of goods and services is determined exclusively by the interaction between supply and demand (that is, between sellers and buyers), without state regulations or controls intervening. It is a system of free competition, whose commercial transactions must occur without coercion, fraud, or mandate of any kind, that is, It is the complete opposite of the planned economy.
The concept of the free market had its origin in 18th century Europe, a time in which nascent industrial capitalism adopted the French expression. laissez faire (“let them do”), attributed to the French physiocrat Vincent de Gournay (1712-1759) and said against economic interventionism.
Furthermore, at that time it was published The wealth of nationsfamous book by the Scottish philosopher Adam Smith (1723-1790), in which free trade was defended (free trade), economic doctrine opposed to protectionism, that is, it advocated international trade without barriers or restrictions, with free mobility of merchandise and the workers themselves.
According to Smith, the “invisible hand” of the market, that is, the struggle between supply and demand, is the only force capable of keeping the economy in balance, and therefore any other type of intervention would do nothing more than corrupt its functioning and destabilize it. In fact, Smith also opposed the existence of monopolies and other forms of dishonest competition among merchants, since by artificially favoring each other, they would be introducing instability to the economic system.
Theories of the free market and non-intervention of the State were popular in the 19th century, especially in Great Britain, although they were not fully adopted by the world powers of the time, which continued to protect their industrialization processes through tariffs and patents. Currently, There are more orthodox positions regarding the interpretation of the free market and others, however, that are heterodox which propose different degrees of economic intervention (mixed economy).
See also: Free trade
Characteristics of the free market
The free market is essentially characterized by the objectivity and impersonality of its processes, that is, by an almost scientific relationship between economic actors, without the intervention of distorting factors such as regulations, tariffs, monopolies or oligopolies, among others.
In general, for the existence of an efficient free market three ideal conditions must be met:
- There must be perfect competition that is, an exchange between sellers and buyers that lacks coercion, monopolies and everything that is not supply and demand.
- Supply and demand must be independent of each other that is, one should not necessarily influence or model the other.
- The offer must be subject only to the availability of economic resources necessary for production.
Although these three conditions are rarely met in reality, this does not prevent liberal economies from trying to achieve a situation as similar as possible, following the premise that an economic balance between supply and demand can only be achieved by “letting things go.” (laissez faire).
Advantages and disadvantages of the free market
The free market doctrine has promoters and detractors, who point out its possible virtues and problems, which can be summarized as follows:
Advantages of the free market | Disadvantages of the free market |
---|---|
It encourages free competition, that is, creativity, innovation and entrepreneurship. | It ignores distributional issues, so it can lead to great inequalities between people and their quality of life. |
It allows consumers to choose freely and reward producers who best meet their needs. | It hands control of the market to companies, which immensely increases their power and influence within the economic circuit itself. |
Avoid the negative consequences that state intervention brings, such as corruption. | It experiences failures when the ideal conditions for free competition do not exist, which happens very often. |
What are market failures?
It is known as market failure. situations of inefficient allocation of resources, which prevent the free market from reaching a situation of equilibrium. The term is attributed to the English philosopher Henry Sidgwick (1838-1900), but its use in economics became popular after 1958, as a way of explaining the reasons why a free market economy does not prosper and is necessary. state intervention.
Some of the most common market failures are:
- Information asymmetries. It occurs when the parties involved in a purchase and sale operation do not have the same information regarding the good or service offered, so that they cannot make the same judgment regarding its value, nor regarding the convenience of the transaction. For example, when a seller ignores that the object he is selling constitutes a collectible relic and therefore sells it far below its true cost.
- Externalities. This is the name given to non-economic events that directly affect the market situation and generate distortions. These externalities can be positive (when they artificially add value) or negative (when they artificially subtract value). For example, a war situation in a distant country can cause a deficit of a product and artificially increase its cost, a situation that benefits other producers of this good, no matter how small and inefficient they may be.
- Non-competitive markets. These are those markets in which some of the economic actors do not have the need to compete, or not on the same terms, because they have a share of control over the market or do not have significant competition. In other words, we talk about monopolies and oligopolies. For example, when a large corporation controls a local market and can sell its goods below actual cost (dumping), artificially removing its competitors from the market, and then imposing whatever prices it wants.
- Public goods and “stowaway” consumers. Public goods are those that the State maintains and that everyone can enjoy, even those who do not contribute (directly or indirectly) to their cost. The latter are called “stowaway consumers” (like clandestine passengers on a ship) and since they cannot be excluded from the enjoyment of public goods, they prevent the market from efficiently allocating resources.
Examples of free markets
The following are examples of situations where free markets take place:
- The so-called “free ports” in a country in which the State removes the taxes and tariffs that it commonly imposes on products and allows their sale and purchase on free terms.
- The dynamics of the “black” or “parallel” dollar in countries with currency exchange control, since to escape state regulations, foreign currency is managed according to supply and demand.
- The purchase and sale of second-hand goods It is usually not subject to regulations, but rather determined by factors related to the availability and condition of the merchandise. Therefore, its commercialization usually occurs on entirely free terms.
Continue with: Law of supply
References
- “Market failures” on Wikipedia.
- “Why are free markets important?” in OECD Better Policies for Better Lives.
- “Master Class: Free market economics and other economic systems” (video) at MCA School.
- “Free Market (economics)” in The Encyclopaedia Britannica.