A free-market Economy is an economic system in which individuals, rather than government, make the majority of decisions regarding economic activities and transactions (see Capitalism). Individuals are free to make economic decisions concerning their employment, how to use or accumulate capital, what expenditures to make, and whether to use their resources now or to save them for later consumption. The principles underlying free-market economies are based on laissez-faire (non-intervention by government) economics and can be traced to the 18th century British economist Adam Smith. According to Smith, individuals acting in their own economic self-interest will maximize the economic situation of society as a whole, as if guided by an “invisible hand.” In a free-market economy the government's function is limited to providing what are known as “public goods” and performing a regulatory role in certain situations.
Public goods, which include defense, law and order, and education, have two characteristics: consumption by one individual does not reduce the amount of the good left for others; and the benefits that an individual receives do not depend on that person's contribution. An example is a lighthouse. One individual's use of light provided by a lighthouse does not reduce the ability of others to use it. In addition, the lighthouse owner cannot restrict individuals from using the light. The latter illustrates the “free-rider” phenomenon of public goods—both those who helped pay for the lighthouse and those who did not will enjoy the same amount of light. The “free-rider” problem can be eliminated if governments collect taxes and then provide public goods.
Government's role in a free-market economy also includes protecting private property, enforcing contracts, and regulating certain economic activities. Governments generally regulate “natural monopolies” such as utilities or rail service (see Monopoly). These industries require such a large investment that it would not be profitable to have more than one provider. Regulation is used in place of competition to prevent these monopolies from making excessive profits. Governments may also restrict economic freedom for the sake of protecting individual rights. Examples include laws that restrict child labor, prohibit toxic emissions, or forbid the sale of unsafe goods.
Proponents of free-market economies believe they provide a number of advantages. They see free-market economies as encouraging individual responsibility for decisions and they believe that economic freedom is essential to political freedom. In addition, many people believe that free markets are more efficient in economic terms. Free markets provide incentives both to individuals to allocate resources, such as labor and capital, among the most productive uses, and to firms to produce goods and services that the public wants, using the most efficient means of production.
Free-market economies are also criticized. Opponents believe that a free-market economy cannot ensure basic social values, such as alleviating poverty, or that the income distribution that results from a free-market economy may not be equitable. A free-market economy may also permit the accumulation of vast wealth and powerful vested interests that could threaten the survival of political freedom.
Alternative economic systems include communism and mixed economies. In communism, the government plans the economy and all means of production are publicly owned. The economy of the former Union of Soviet Socialist Republics was an example of a planned economy: all decisions regarding production and distribution were made by the government. In contrast, a mixed economy is one where the government does some planning and owns or controls more industries than in a free-market economy. Governments may own key industries such as steel, aviation, and banking, while the individual still plays an important role. Sweden and France are examples of mixed economies.
A free market is a market where the price of an item is arranged by the mutual consent of sellers and buyers, with the supply and demand of that item not being regulated by a government (see supply and demand); the opposite is a controlled market, where supply and price are set by a government. However, while a free market necessitates that government does not regulate supply, demand, and prices, it also requires the traders themselves do not coerce or defraud each other, so that all trades are morally voluntary.
The notion of a free market is closely associated with laissez-faire economic philosophy, which advocates approximating this condition in the real world by mostly confining government intervention in economic matters to regulating against force and fraud among market participants. Hence, with government force limited to a defensive role, government itself does not initiate force in the marketplace beyond levying taxes in order to fund the maintenance of the free marketplace. Some free market advocates oppose taxation as well, claiming that the market is better at providing all valuable services including defense and law. Anarcho-capitalists, for example, would substitute arbitration agencies and private defense agencies.
In political economics, the opposite extreme to the free market economy is the command economy, where decisions regarding production, distribution, and pricing are a matter of governmental control. In other words, a free market economy is "an economic system in which individuals, rather than government, make the majority of decisions regarding economic activities and transactions." In social philosophy, a free market economy is a system for allocating goods within a society: supply and demand within the market determines who gets what and what is produced, rather than the state. Early proponents of a free-market economy in 18th century Europe contrasted it with the medieval, early-modern and mercantilist economies which preceded it.
The key idea of a free market is voluntary exchange. If an exchange takes place under coercion or fraud, then that exchange is not considered a free market exchange. For example, if someone threatens someone with a gun to purchase what he is selling then is a not a free market. If the government legally prevents a merchant from selling his goods at any prices he wishes and that buyers agree upon, that is not a free market. Or, if the government decrees what quantity of a commodity one must manufacture it is not a free market. Thus, the operation of supply and demand is not sufficient for a free market if decisions on supply and demand are made under the threat of coercion. If an individual is lied to in order to persuade him to purchase something, such as when a product or service is misrepresented, this is not considered morally voluntary either. Thus, a free market is one without "force or fraud."
The necessary components for the functioning of an idealized free market include the complete absence of artificial price pressures from taxes, subsidies, tariffs, or government regulation (other than protection from coercion and theft), and no government-granted monopolies (usually classified as coercive monopoly by free market advocates) like the United States Post Office, Amtrak, arguably patents, etc.
In an absolutely free-market economy, all capital, goods, services, and money flow transfers are unregulated by the government except to stop collusion that may take place among market participants. As this protection must be funded, such a government taxes only to the extent necessary to perform this function, if at all. This state of affairs is also known as laissez-faire. Internationally, free markets are advocated by proponents of economic liberalism; in Europe this is usually simply called liberalism. In the United States, support for free market is associated most with libertarianism. Since the 1970s, promotion of a global free-market economy, deregulation and privatization, is often described as neoliberalism. The term free market economy is sometimes used to describe some economies that exist today (such as Hong Kong), but pro-market groups would only accept that description if the government practices laissez-faire policies, rather than state intervention in the economy.[specify] An economy that contains significant economic interventionism by government, while still retaining some characteristics found in a free market is often called a mixed economy.
Low barriers to entry
A free market does not require the existence of competition, however it does require that there are no barriers to new market entrants. Hence, in the lack of coercive barriers it is generally understood that competition flourishes in a free market environment. It often suggests the presence of the profit motive, although neither a profit motive or profit itself are necessary for a free market. All modern free markets are understood to include entrepreneurs, both individuals and businesses. Typically, a modern free market economy would include other features, such as a stock exchange and a financial services sector, but they do not define it.