Free market economic system

In this short topic video we look at the key features, advantages and potential drawbacks of a free market economic system.

What is an economic system?

An economic system is a network of organisations used to resolve the problem of what, how much, how and for whom to produce

What is a free market economy? I.e. a laissez-faire system

• A free market is a system of buying and selling goods and services that is not under the control of the government
• It is where people can buy and sell freely, or an economic system where free markets exist, and most companies and property are not owned by the state.
• There is limited government intervention to influence or change the outcomes of market activity

Key aspects of a free market system

1. Light touch regulation of labour, product and financial markets
2. Legal system focuses on protecting property rights
3. Freedom to trade internationally and promote free movement of capital and labour
4. Limited market intervention (e.g. indirect taxes, subsidies, maximum and minimum prices)
5. Small size of government (including a small size/scope of welfare benefits)
6. Low tax environment / focus on “ease of doing business”
7. Consumer preferences determine allocation of resources

Overall, in a free market economy, the economic problem of what goods should be produced is usually solved by consumers expressing their tastes and preferences in their pattern of spending

Economic Freedom Index - Top Ranked Countries for 2019

Potential advantages of free market systems

1. An efficient allocation of scarce resources – factor resources tend to go where the expected profit is highest.
2. Competitive prices for consumers as suppliers look to increase and then protect market share.
3. Competition drives innovation & invention bringing higher profits for businesses and better products for consumers.
4. The profit motive stimulates investment which encourages economies of scale and lower prices for consumers.
5. Competition through trade in goods and services helps to reduce domestic monopoly power and increases choice.

Potential disadvantages of free market systems

Free markets can fail to achieve an economically and socially efficient and equitable allocation of resources – there are numerous potential causes of market failure that may require government intervention.

1. Free market activity can lead to a rise in the scale of income and wealth inequality as shown by rise in the Gini coefficient
2. Businesses can develop monopoly power which leads to higher prices and damage to consumer welfare
3. Under or non-provision of pure public goods (e.g. defence – goods which are non-rival and non-excludable)
4. Under-provision of merit goods such as health and education – which many cannot afford – leading to lower social welfare
5. Free markets may fail to address negative externalities from production and consumption – unsustainable growth
6. Deregulated financial markets often prone to bouts of instability – the fall out from which affects millions not directly involved