1.1.6 - Free market economies

• In a free market economy, individuals are free to make their own choices and own the factors of production without government interference
• In a free market resources are allocated through the price mechanism
• Advantages of a free market:

  • The system is automatic due to the invisible hand
  • There is high motivation as people know working hard could lead to high potential rewards
  • Because firms are in competition, they will produce goods at the lowest cost they can, ensuring productive efficiency
  • political freedom
• The invisible hand is when resources are moved out of production of a good when people stop wanting it or costs are too high.
• Disadvantage to the free market:

  • There tends to be high levels of inequality, since the rich own more factors of production and so can grow richer
  • There may be a lack of merit goods and little control of demerit goods.
  • There is the problem of externalities.
  • If competition disappears then there may be monopolies,
• In a command economy, all factors of production, except labour, is owned by the state and labour is directed by the state.
• Friedrich Hayek (1899-1992) argued that state control of the economy leads to the loss of freedom. He believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom.
• Adam Smith (1723-1790) believed in the free market economy and the laissez-faire approach by governments. He explained how there was an ‘invisible hand’ in the market which allocated resources to everyone’s advantage, allowing the greatest good for the greatest number of people.