Free market economic system
Theoretical support for a free market was strongly supported by Adam Smith in his book, 'The Wealth of Nations'. The wealth of nations tried to explain that; when people try to maximise their individual utility it actually leads to the best outcome for the rest of society.
However, Adam Smith was aware of some limitations of the free market. For example, he was aware of how monopoly power could be abused. But, basically his theories crystallised the theoretical underpinnings of a free market approach. Many of his arguments remain relevant today.
Benefits of a free market
- Firms have incentives to be efficient and provide goods and services demanded by consumers
- It avoids the bureaucracy often involved in government intervention.
- The profit motive provides an incentive to cut costs and make efficient use of scarce resources
- Economic freedom is important for personal freedom.
Problems of a Free Market
"Capitalism is the astounding belief that the most wickedest of men, will do the most wickedest of things for the greatest good of everyone."- John Maynard Keynes, as quoted in Moving Forward: Programme for a Participatory Economy (2000)
A free market has various problems. This is a silly mnemonic to help you remember them. PIMM FACED.
P - Public Goods are not provided in a free market. A public good is a good with the characteristics of non rivalry and non excludability. Examples include street lighting and national defence.
I - Inequality. A free market provides no social security net for those who are unemployed or on low income. Furthermore the nature of a free market is that the benefits tend to accrue to a small number of people who have the advantage of property and monopoly power
M - Monopoly. In an unchecked free market, monopolies can easily develop. This means the owners are in a position to set high prices and exploit both consumers and workers.
M - Merit Good - Education and health care. Under-provided because people underestimate the benefits of going to school e.t.c.
F - Factor immobility. Geographical unemployment. Occupational unemployment through lack of skills
A - Agriculture. - Agriculture is prone to market failure e.g. weather can harm crops
C - Cyclical Instability - economic recessions and the corresponding unemployment
E - Externalities - Over-consumption of goods like tobacco with negative externalities
D - De merit goods - Overconsumption of goods like alcohol, where people overestimate the personal benefits, underestimate the costs of getting drunk.
Show MoreTHE ADVANTAGES OF FREE MARKET ( DISADVANTAGES OF COMMAND ECONOMY )
1.Efficiency. free market economies are very competitive. Most of their industries are assumed to be perfectly competitive and so allocative and productive efficiency will occur.As their main aim is profit motive so free market economies allocate their resources more efficiently as compared to planned economy. Decisions about what to produce are made by the people who will actually consume the goods. Planners are less likely to make the correct decisions across the whole economy.
2.Choice.In free market consumer sovereighnty prevails. Firms will produce whatever consumers are prepared to buy not what they think they think they would like to buy.As consumer needs are…show more content…
But there may be a problem with merit goods and demerit goods. Merit goods, like health and education, tend to be under provided in a free market. Certainly in the USA the public health system is a 'last resort' system. People are advised to buy health insurance. Of course, the poor might not be able to afford this, and some people might simply decide not to bother if they feel particularly healthy. Demerit goods are bad for you. Government should ban class A drugs, and tax cigarettes and alcohol heavily. A government with a limited role might not take enough action in this area, causing health problems for the economy.
Of course, the advantage of a command economy is that the strong government will make sure that public and merit goods are consumed at the right levels and that demerit goods are banned or taxed heavily.
Free market economies are likely to produce more pollution, which is bad for the environment. Command economies can make sure that the production processes that they chose are as environmentally friendly as possible. They should be able to make sure that the level of output is the socially optimal level of output. Governments can try to force firms into producing the socially optimal level of output through the use of taxes, but governments with a limited role will not be keen to use taxes. Although the tax on petrol is high in the UK, it still doesn't cover the problems caused by the exhaust emissions (in health as well as the