What is free market economy? characteristics and effects

What is free market economy? This is an economic system whereby the supply and demand expressed by sellers and buyers determine the prices of goods and services. One of the distinct characteristics of a free market economy is that it operates without the intervention of the government or any other external authority.

The free market is usually contrasted with a regulated market, where a government intervenes in supply and demand by means of various methods such as taxes or regulations. This is not the case for a free-market economy, as the prices for goods and services are set solely by the bids and offers of the participants. In this article, we will discuss what a free market economy is, its characteristics, and its effects.

What is free market economy?
What is free market economy?

Related: Disadvantages of free enterprise economy

What is free market economy?

A free market economy is also known as free enterprise. It is an economic system that is based on supply and demand with little or no intervention from the government. This economic system is characterized by a spontaneous and decentralized order of arrangements whereby individuals make economic decisions.

In other words, a free-market economy is an unregulated system of economic exchange, in which quality controls, taxes, quotas, tariffs, and other forms of centralized economic interventions by the government are either minimal or do not exist. In practice and in principle, free markets are characterized by voluntary contracts, private property rights, and competitive bidding for goods and services in the marketplace. This structure is definitely in contrast to the coercive activity, public ownership of property, and fixed or controlled distribution of goods and services that occurs in communism.

Furthermore, in the absence of central planning, a free-market economy tends to produce capitalism, even though it is possible that voluntary socialism or even agrarianism could result. In Western countries, free markets are associated with laissez-faire capitalism and philosophical libertarianism. Nonetheless, a free market economy is still different from capitalism.

See also: Free enterprise benefits

Examples of free market economy countries

  1. Australia
  2. Austria
  3. Bahamas
  4. Barbados
  5. Belgium
  6. Bulgaria
  7. Canada
  8. Chile
  9. Czech Republic
  10. Cyprus
  11. Denmark
  12. Estonia
  13. Finland
  14. Georgia
  15. Germany
  16. Iceland
  17. Ireland
  18. Israel
  19. Italy
  20. Japan
  21. Latvia
  22. Lithuania
  23. Luxembourg
  24. Malta
  25. Netherlands
  26. New Zealand
  27. Norway
  28. Poland
  29. Portugal
  30. Singapore
  31. South Korea
  32. Slovenia
  33. Sweden
  34. Switzerland
  35. Taiwan
  36. United Arab Emirates
  37. United Kingdom
  38. United States
  39. Uruguay

There are several examples of free market economy countries that rank as ‘mostly free’ to ‘moderately free’ market economies. Listed above are some examples. According to the Heritage Foundation’s 2022 Index of Economic Freedom, as of 2nd Jun 2022, Singapore, for instance, ranked first being 84.4.% economically free. Singapore as one of the examples of a free market economy has extremely low tax rates, a highly capitalist system of economics, and minimal regulations on businesses.

Switzerland is another country with a free market economy. It ranks close to Singapore at 84.2% free and is followed by Ireland at 82.0%. In Switzerland and Ireland, there are little or no tariffs, with few restrictions on investments and business creation. Also, there are strong private property rights protections in both countries.

New Zealand, which is another country with a free market economy, ranked fourth at 80.6% free. The country has low tariffs and strong private property rights. The government of New Zealand provides businesses with lots of flexibility which does not constrict them with overly complicated regulations or licensing procedures.

Furthermore, other free market countries such as Taiwan, Luxembourg, Estonia, the Netherlands, Denmark, and Finland round out the 2022 top ten as of Jun. 2, 2022. The United States, which is considered to be among the world’s most advanced financial markets, happens to be only 72.1% economically free, as of 2022, ranking 25th.

On the other hand, countries like Zimbabwe, Sudan, Cuba, Venezuela, and North Korea happen to be the five least free market economy countries in 2022.

Read also: Arguments Against Capitalism

What are the characteristics of a free market economy?

A free market economy is characterized by several principles such as the limited role of government, the freedom for individuals to choose businesses, the right to private property, profits as an incentive, competition, and consumer sovereignty.

A free enterprise economy operates by individuals participating in economic activities for personal gain. That is, a person sees a need and creates a business to fill that need; others accept jobs to work with the establishment, whereas others buy the product. Each stage in a free market depends on someone being motivated to act and reap the benefits of their efforts.

Therefore, the competition to sell the most product, get paid the highest wage, and improve a personal standard of living is what drives the activities of every individual that participates in a free-market.

Characteristics of a free market economy

  1. Limited role of government
  2. Demand and supply
  3. Consumer sovereignty
  4. Economic freedom
  5. Right to private property
  6. Profit motive
  7. Competition
  8. Voluntary exchange

Let’s further discuss the characteristics of a free market economy:

Limited role of government

A free market as an economic system is based on demand and supply with little or no intervention from the government. It differs from a regulated market in which the government intervenes in demand and supply by means of various methods such as taxes or regulations. Instead of government policy deciding how resources are allowed, a free-market economy is rather characterized by the consumers having a greater voice in the economy.

However, in as much as a free market economy should be free of unnecessary government interference, it doesn’t necessarily mean it is free of government regulations. The government still has a role to play in this economic system. They act like a referee by enforcing people’s individual rights to be secured in their person and property, enforcing rules of fair play in the economy, enforcing contracts, and ensuring that consumers are not defrauded.

In addition, in this system, the market faces no bureaucracy as market participants are usually allowed greater expression and flexibility. That is, entrepreneurs aren’t constrained by public policy or directed on what should be produced. Hence, a cornerstone theory of a free-market economy is that the best companies will innovate to continue to meet market demand, while companies that fail will cease to exist as they will no longer have a place in the market.

Demand and supply

Demand and supply are definitely characteristics of a free-market economy. The economic market pressure from people trying to buy a good or service is referred to as demand for a good or service. In a free market, consumers dictate the demand, and businesses must regulate the supply, both output, and containment, in order to not flood the market.

Buyers have a maximum price that they are willing to pay for a good or service, and sellers as well have a minimum price at which they are willing to offer their good or service. Hence, the point at which the supply and demand curves meet is the equilibrium price of the goods and quantity demanded. When sellers willingly offer their goods at a lower price than the equilibrium price, the difference is received as producer surplus. When buyers willingly pay for goods at a higher price than the equilibrium price, the difference is received as consumer surplus.

Furthermore, in a free market economy, the individuals and firms that take part in transactions have the liberty to enter, leave or participate in the market as they so choose. In this system, prices and quantities are allowed to adjust according to economic conditions in order to reach equilibrium and allocate resources.

Nonetheless, in several countries around the globe, governments seek to intervene so as to achieve certain social or political agendas. Governments may intervene in the market through actions such as imposing a minimum wage (price floor) or erecting price controls (price ceiling) in an attempt to create social equality or equality of outcome.

Consumer sovereignty

A free market economy is characterized by consumer sovereignty. In this system, consumers determine the ultimate prices of a good, the products that are needed in a market, and what goods fail or succeed. Therefore, if a certain good is scarce and high in demand, its price will be high, whereas if the good is plentiful and low in demand, its price will be low.

Hence, it is left to businesses in a free market economy to understand these consumer preferences and adjust their operations accordingly. Such an economic system tends to lead to socially optimal prices as far as there is adequate competition in the economy.

Economic freedom

One of the characteristics of a free market economy is economic freedom. This is the freedom to pursue financial gains such as the right to create a business, invest as desired, search for employment at a specific company, quit a job, and any other economic activity.

In a free market economy, consumers have the freedom to choose who to transact with as well as what they want to pay (a seller has to agree for the transaction to occur). That is, in a free market, there is freedom to charge or pay what one prefers, freedom of choice, and freedom to express oneself through the creation of any product that one would like.

This economic freedom is definitely one of the advantages of a free market economy. The freedom allows individuals to transact with little to no restricting barriers set by policy or trade regulation. Hence, individuals are allowed to creatively express and transact based on a seemingly endless range of consumer choices.

Right to private property

In a free-market economy, individuals have the right to acquire private property. This is one of the most prominent characteristics of a free market. In this system, the right to private property allows properties to be owned by individuals and companies, and not the federal government.

Individuals can own and make decisions about the use or sale of land, private property, and other assets. Hence, they can control their property rather than using or renting property belonging to the government.

Profit motive

The profit motive is another characteristic of a free market economy. In this economic system, the goal is to make money in a freely-flowing society. People have the right to buy and sell goods for personal profit, with fewer restrictions compared to other restrictive forms of economies. Hence, in a free market economy, a business owner is able to keep all the money he or she earns.

A free-market economy, therefore, brings about a large financial incentive to work hard and create successful businesses. For instance, a worker in a free market system could work overtime and make extra money, but in a different economic system like a communist system, no matter how much the worker works, he might just only be given a certain wage by the government.

Self-interest is definitely one of the main factors behind a successful free-market economy. The majority of businesses have been established in the best interests of the people that started them. This kind of economy, therefore, provides people the opportunity to work for themselves and allows them to earn a living in the way that they want to.

Competition

One of the free market economy characteristics is that it brings about competition. As an economy that is based on the relationship between supply and demand, the free market promotes healthy competition. In this system, sellers and buyers compete; the sellers try to sell goods for higher prices while the buyers try to purchase goods for lower prices or more favorable terms. Market equilibrium is then met when these two parties eventually agree to come together.

Companies also compete with other companies to offer better goods or services to consumers. This sort of competition among firms brings about innovation. When a firm offers more extensive goods and its profit margins increase, its competitors definitely get inspired to be innovative enough to retain or gain some of that market, thus offering more products or services in varied, and more efficient ways.

Voluntary exchange

In a free market system, consumers have the right to choose to or not to exchange goods. Therefore, voluntary exchange is one of the free market economy characteristics. In this system, people can not be forced into trade or forced to consume any products. In fact, the market is driven by consumers as the value of various goods and services is determined by the potential buyers of that good or service.

If there are multiple market suppliers, consumers have the right to choose who to transact with and what they want to pay, as far as the seller agrees to this price. As a matter of fact, consumers are the ones that determine the prices of goods in a free market economy.

Related: Free enterprise characteristics

Free-market economy effects

  1. Faster and more responsive markets
  2. Greater economic growth
  3. Limited goods or services to consumers
  4. Efficiency
  5. Destabilization
  6. Inequality
  7. Public goods tend to suffer
  8. Unfavorable activity as a result of prioritization of profits
  9. Severe economic downturns

Here are some of the effects of a free market economy:

Faster and more responsive markets

One of the effects of a free-market economy is that it brings about a faster and more responsive market. In a command economy, the government acts to rectify market failures whereas, in a free market economy, the market theoretically self-regulates as consumers and manufacturers make the economic decisions necessary to adjust to new conditions.

In this economic system, the means of production are diffuse and privately owned, and as a result, the consumers and manufacturers can quickly create a new normal. Also, in a free market economy, competitors can enter any market at any time which means that consumers have the market power and economic freedom to influence what producers sell as well as the price.

Greater economic growth

A free market economy causes greater economic growth because the pursuit of profit tends to motivate and encourage actors in a free-market to work harder and produce more out of self-interest. This definitely contributes to faster and more sustainable economic growth than other systems can achieve.

Why are free market economies able to attain economic growth?

One of the major reasons why free market economies are able to attain economic growth is because it encourages more competition. This is one of the effects of a free-market economy. As a result of competition, more companies are established, thus, creating a greater number of jobs. More jobs would mean more money is poured back into the economy by consumers. This system leads to the citizens of a country being wealthier and this is why countries like the U.S. with a free market tend to have a higher economic growth rate.

Limited goods or services to consumers

One of the effects of a free market economy is that it may result in limited goods or services. This is one of the disadvantages of a free market economy. In this kind of economic system, due to unlimited freedom and self-interest, goods that are generally not profitable to manufacture will not be produced. This is because there is no economic incentive for an organization to produce such goods except if there were government aid or stipends.

A free market system may also cause limitations on where goods are delivered. For instance, government funds may partially pay for telecommunication services to be distributed to rural areas, however, without this funding, the communities in the rural areas may not receive the service.

Efficiency

The competition that comes with a free market economy brings about efficiency. This is no doubt one of the advantages of a free market economy. A company that is up against another company that offers similar products or services tends to use the resources at its disposal efficiently.

As a result of competition, manufacturers of goods and services are therefore forced to produce efficiently. That is if a manufacturer creates products very efficiently, and another manufacturer produces a similar product less efficiently, the more efficient business tends to make a profit while the other tends to lose money. If the less efficient business doesn’t increase its efficiency, it will definitely be forced out of the market.

Therefore, in a free market economy, the positive effect of the competition between businesses puts pressure on them to innovate and create new ways to produce products better and as efficiently as possible in order to outperform their competitors.

Destabilization

In as much as the pursuit of profit can cause growth and innovation in a free market economy, it can also encourage actions that make the market less accessible or even destabilize the economy at large. For instance, without the intervention of the government like price controls, drug manufacturers can raise prices on a medication that is high in demand. Also, without centralized economic policies that govern financial markets, speculation (purchase of an asset with the hope that it will become more valuable shortly) can easily lead to recessions.

Inequality

Many economists have argued that inequality is inevitable in a purely free market economy because when one person gains, another likely loses. For instance, hoarding property rights can create a system in which the owners continue to make a profit and the consumers never get a share. This means that, without oversight in place, there is really nothing to stop the rich from getting richer and the poor from getting poorer.

Public goods tend to suffer

One of the disadvantageous effects of a free market economy is that public goods tend to suffer. A free market system is driven by self-interest and as a result, the market doesn’t consider morality. Due to this, public goods such as public health and the environment can actually suffer because there is no incentive to direct resources toward them.

Unfavorable activity as a result of prioritization of profits

A free market economy may also cause unfavorable activity due to the prioritization of profits. Take, for instance, the case of Enron where the company did not follow public reporting regulations, which resulted in its financial ruin. When there are little to no rules to follow, companies within a free market system may sacrifice environmental standards, worker safety, or ethical behavior in favor of making more money.

Severe economic downturns

An economic downturn could be one of the effects of a free market economy. A free market doesn’t come with bailouts which means that economic downturns are theoretically more severe. This is because public funds can’t be used to aid failing organizations that would cause major ripple effects by dissolving. This is especially true in today’s interconnected society where one large bankruptcy could negatively affect organizations around the globe.

Read also: Importance of Free Market

Last Updated on November 3, 2023 by Nansel Nanzip Bongdap