A free market or free market is one in which the prices of goods and services are determined by the interaction of suppliers and demanders without the intervention of the government or any other external agent.
In a free market, there is no limitation on the price at which it can be sold or the quantity to produce. Sellers are free to sell what they want and consumers are free to choose who they will buy from. The equilibrium price will be the result of the intersection of supply and demand.
The fundamental thing for the existence of a free market system is that there is no force or power that can intervene in the market. In such a way that the basis for the establishment of the price is the free interaction between suppliers and demanders.
What is Free Market
In this type of market, producers or suppliers have complete freedom to decide on the productive factors. What, how much and for whom to produce is decided by the employer. In turn, consumers are free to choose how much to buy, how much to buy of a given good, and from whom they will buy it.
The free market presupposes essential economic conditions, such as free competition. In which there are no restrictions for the free entry and exit of companies, and where consumer sovereignty prevails.
So, on one front is the producer and the other is the consumer. Both producer and consumer resolve their needs for the exchange of goods and services in full freedom.
Characteristics of the free market
The essential characteristics of the free market are:
- There is no government intervention in the form of regulations, pricing, quotas, or any form of intervention.
- Bidders and applicants interact freely.
- Bidders can choose what, how much, and at what price to sell.
- Consumers can choose, considering the information they have available and their personal preferences, what, how much and from whom they will buy.
When is the free market efficient?
The free market will result in inefficient resource allocation when it is close to perfect competition. That is when there is a high number of sellers and buyers so that none of them can affect the market price. In addition, there should be no significant barriers to entry or exit so as to ensure free competition.
However, the free market will not be efficient in the following situations:
- When there are market failures: such as information asymmetries, externalities, etc.
- Where the conditions for the free entry and exit of firms do not exist: For example, when a high investment is required to enter the market, the existence of strong economies of scale, etc.
- In markets where there are anti-competitive agreements or practices.
Advantages of the free market
The resulting price and quantity will be appropriate to meet the needs of consumers and resources will be used in the best possible way. The free market is the most efficient mechanism for allocating resources when there is a competitive market. According to Hayek, prosperity is driven by creativity, entrepreneurship, and innovation, which are only really possible in a free market.
Among the advantages of a free market system are the freedom of choice of consumers. Thus, the adjustment between supply and demand is, in theory, more faithful to economic reality. In other words, the free market allows prices to be priced very close to the true value perceived by the consumer, according to economic theory.
For this it is necessary that transaction costs, taxes and regulations are not eliminated. Thus, this would result in a lower price or, alternatively, in obtaining higher quality products at a similar price.
In addition, it allows us to avoid the costs of government intervention that include errors, corruption, lack of information or inertia, for example.
Disadvantages of the free market
The free market does not take into account distributional issues, so there can be great inequalities between people’s income and their quality of life. In addition, the free market can fail when the conditions are not met for competition in the market.
In this sense, there are many people, including economists and political leaders, who argue that the free market can lead to widening the differences between rich and poor.
Given that companies, due to their economic power, can have control over the market. For them, they recommend that the State should maintain a certain margin of control to avoid perverse tendencies of those companies that act breaking the order of the system.
In view of these possible failures of the free market system, many argue that the State is not only there to intervene in conflict solutions between producers and consumers, through the creation and establishment of corrective laws.
Adam Smith enacted however that the free market acts as an invisible hand that allows society to achieve maximum social welfare as long as each person in the market freely seeks his own interest.