A free market economy is a type of economy that promotes the production and sale of goods and services, with little to no control or involvement from any central government agency.
In a free market economy, firms and households act in self-interest to determine how resources get allocated, what goods get produced, and who buys the goods. A free market economy is opposite to how a command economy works, where the central government gets to keep the profits.
Advantages Of A Free Market
1. Consumer Sovereignty
In a free market, producers produce what consumers want at a reasonable price. It gives the consumer more choice for their purchases.
2. Absence of Bureaucracy
Free markets reduce cost, lead to more innovation and research & development through the absence of red tape. Entrepreneurs don’t have to wait for the government to tell them what to make. They study demand, research trends, and meet the customer’s needs through innovation. This independence also encourages competition amongst firms to improve their product and service.
3. Motivational Influence of Free Enterprise
Guided by the invisible hand, entrepreneurs take a risk to fulfill consumer demand. Those entrepreneurs who succeed are rewarded with profits. (The invisible hand is an economic concept where market demand act as signals for producers, i.e., because consumers want and are willing to pay for bread, a baker has the incentive to produce bread).
4. Optimum Allocation of Resources
Resources in the market are better distributed and allocated. Since consumers are willing to pay for a certain quantity of a product, producers are willing to pay to acquire raw materials. Otherwise, producers produce too much of a good that no one wants. It also encourages firms to be more efficient as they seek to produce at the lowest price possible to maximize their profit.
Disadvantages Of A Free Market
These are four disadvantages of a free market economy.
1. Poor Quality
Since profit maximization is the biggest motivation for firms, they may try to reduce their costs unethically by polluting the environment or by exploiting workers.
2. Merit Goods
Goods and services that are not profitable will not be produced/run. Rural communities will suffer as a result, e.g., regarding transport and post. For example, rural hospitals may not be profitable to run but are necessary.
3. Firm Power
Large firms can still dominate certain markets, even where there is competition, and exploit suppliers (by squeezing their prices down) and consumers (by charging higher selling prices) to maximize profits. For example, Amazon has done this in the book industry by dictating unfair terms to publishers.
Certain members of society will not be able to work with the elderly or the unemployed (because their skills aren’t marketable). They will be left and will fall into poverty (remember if there is no government, they cannot be helped).