1.1.6 Free Market

• Free market economies


  Also known as laissez-faire economies, where governments leave markets to their own devices, so the market forces of supply and demand allocate scarce resources
• Free market economies


  • Economic decisions are taken by private individuals and firms, and private individuals own everything. There is no government intervention
  • In reality, governments usually intervene by implementing laws and public services, such as property rights and national defence
• Adam Smith


  Famous free market economist, developed the theory of the invisible hand of the market
• Friedrich Hayek


  Famous free market economist, argued that government intervention makes the market worse
• How prices are determined in free market economies

  Prices are determined by the 'spending votes' of consumers and businesses
• Adam Smith recognised some of the issues with monopoly power that could arise from a free market
• Hayek argued that the Fed caused the 1930s crash by keeping interest rates low and encouraging 'malinvestments'
• What is determined in a free market economy

  • What to produce: determined by what the consumer prefers
  • How to produce it: producers seek profits
  • For whom to produce it: whoever has the greatest purchasing power in the economy, and is therefore able to buy the good
• Advantages of free market economies

  • Firms are likely to be efficient because they have to provide goods and services demanded by consumers. They are also likely to lower their average costs and make better use of scarce resources. Therefore, overall output of the economy increases
  • The bureaucracy from government intervention is avoided
  • Some economists might argue the freedom gained from having a free economy leads to more personal freedom
• Disadvantages of free market economies

  • The free market ignores inequality, and tends to benefit those who hold most of the wealth. There are no social security payments for those on low incomes
  • There could be monopolies, which could exploit the market by charging higher prices
  • There could be the overconsumption of demerit goods, which have large negative externalities, such as tobacco
  • Public goods are not provided in a free market, such as national defence. Merit goods, such as education, are underprovided
• Command economy


  This is where the government allocates all of the scarce resources in an economy to where they think there is a greater need. It is also referred to as central planning
• Karl Marx


  Saw the free market as unstable and argued for the "common ownership of the means of production"
• What is determined in a command economy

  • What to produce: determined by what the government prefers
  • How to produce it: governments and their employees
  • For whom to produce it: who the government prefers
• Advantages of command economies

  • It might be easier to coordinate resources in times of crises, such as wars
  • The government can compensate for market failure, by reallocating resources. They might ensure everyone can access basic necessities
  • Inequality in society could be reduced, and society might maximise welfare rather than profit
  • The abuse of monopoly power could be prevented
• Disadvantages of command economies

  • Governments fail, as do markets, and they may not be fully informed for what to produce
  • They may not necessarily meet consumer preferences
  • It limits democracy and personal freedom
• Mixed economy


  This has features of both command and free economies and is the most common economic system today. There are different balances between command and free economies in reality
• The market is controlled by both the government and the forces of supply and demand
• Governments often provide public goods such as street lights, roads and the police, and merit goods, such as healthcare and education
• What is determined in a mixed economy

  • What to produce: determined by both consumer and government preferences
  • How to produce it: determined by producers making profits and the government
  • For whom to produce it: both who the government prefers and the purchasing power of private individuals