Free Market in the Economical World and Business - Assignment Example

Question Preamble Define Free Market A free market is a market economy whose control lies with the supply and demand of goods and services, with no government control. A free market is the ideal market economy in which buyers and sellers transact freely based on mutual agreement on the prices of goods and services without the intervention of the government through subsidy, taxes, or regulations. Free market stocks in financial markets imply those securities whose availability does not affect their prices, and thus their transaction is wide. In foreign exchange, a free market is a market where the exchange rates are not influenced by the government: they rise and fall freely under the control of demand and supply for currency. Explain how the system works to allocate resources The allocation of resources depends on supply and demand of those resources in a free market economy. The buyers and sellers, or their agents undertake all the exchanges and transaction voluntarily (Friedman, 2003: 36). Both the seller and the buyer accept the transaction because both expect to gain from it. Consequently, the two may repeat the exchange conditions the next time (or refuse to transact) if their expectation was met (or disregarded) in their past transactions. Ultimately, the reason for engaging in the transaction is that both the parties expect to benefit from the exchange. This is the main reason that distinguishes the free market from the free trade of the mercantilist period, expounded by French essay-writer Montaigne. According to Montaigne, the mercantilists held that in any trade transaction, there must be a loser and a winner: the loser is the “exploited party” while the winner is the “exploiter”. The mercantilists’ belief is invalid because the eagerness and even willingness of both the sellers and the buyers mean that they expect to benefit. Translating the trade of free market in modern game-theory jargon, transactions are a win-win exchange. They result to a positive sum rather than the conventional “negative sum” or “zero sums” game. Two factors determine the availability and allocation of resources in a free market: the value of the resources according to each participant, and the bargaining skills of the participants. How the buyers value the resources comparative to the other resources they could buy largely determine the distribution and allocation of these resources in the market (Friedman, 2003: 82). The exchange terms, or prices, depend on the quantity (measure) of the particular resource in the given market set up. Ultimately, the allocation of the resources depends on their availability measure in the market in relation to the evaluation of the buyers. In summary, resource allocation relies on their demand and supply. In the supply of a resource, an increase in its price reflects an increase in demand on the mind of the buyers resulting to more money bidding for it, thus the price of the resource shoots up. The reverse will occur if the price, and thus the demand, for the resource decrease. In contrast, the buyer’s evaluation is that the increase in supply of a resource brings the value of the resource down. The reverse occurs when the supply of the resource decreases. From the demand and supply effects on the allocation of resources, the free market incorporates a highly interactive and complex pattern of transactions. Arguments in favor of this system The manner in which the free market works to allocate resources has come under debate and criticisms by economists. Nevertheless, the free market has four distinct arguments that enforces it existence, and which are discussed accordingly. The first argument is the efficiency of allocating scarce resources in the economy. This argument relates to the neoclassical economic tradition of benefits for all the participants in the transaction. In a completely free market, supply of goods and services matches their demand. The participants maximizes their benefit in the exchanges, everybody is a winner. Secondly, free markets take advantage of information in the society freely. According to Hayek’s essay on knowledge use in society, centralized planning does not adequately capture the information on issues like materials, production techniques, demand, and others. Information is expensive in centralized planning. In contrast, free markets allow the society have a type of distributed cognition. The third argument bases its foundation in the works of Schumpeter, Capitalism, Democracy, and Socialism. Refuting the first argument, Schumpeter states that markets are good: not in their efficient allocation of resources but rather in their promotion of innovation (Friedman, 2003: 199). He adds that capitalism equals innovation, which translates to market success. Free markets apply capitalistic principles in their operations. Lastly, free markets reduce power and discretion. In a free market, no participant has the ultimate power to set the prices, thus no participant has power over the other. There are no fights, nobody tells the other what to do, and the system automatically runs. In his work the great Transformation, Karl Polanyi names this a “stark utopia”. Define Market Failure Market failure is an economic concept that illustrates the inefficiency of allocation of resources in a free market. In application, it means that there is another possible outcome in which a market participant may be made better off without necessarily making another worse off (Mankiw, 2009: 152). Market failure occurs because of inadequate economic factors that prohibit equilibrium, like self-interest that leads to inefficiency. Retrieved on November 25, 2011, from http://www.bized.co.uk/educators/16-19/economics/marketfail/presentation/failure3_map.htm Explain how it can occur Market failure may occur from a variety of reasons. The economic situation may occur when one participant in the market posses power that can prevent efficient transactions from taking place, for instance, a monopoly. Secondly, the situation may occur if an efficient transaction happens to incorporate side effects, or externalities, that reduce efficiency in other market segments, or the general economy at large. Lastly, market failure may occur due to the nature of the goods or services in the market. Occurrence of market failure under the influence of monopoly results to prohibiting the normal demand and supply mechanism that determine fair prices in the market. Market situation that possesses characteristics of single buyer or seller (monopoly), or else cartels of buyers or sellers (oligopolies) lock out non-members in the determination of market prices (). An example is OPEC, which determines the quantity of production without the influence of prevailing market conditions. Such disproportionate accumulation of power deters with the price equilibrium, which is one of the conditions that facilitate efficient allocation of resources in a market. In such a situation, business decisions tend to be irrational, with people either consuming or producing too much that result in deficiency or surpluses in the market respectively. This results in suffering of the economy from the lack of equilibrium in demand and supply. A transaction between two market participants may have significant impacts to other participants lacking direct participation in the transaction agreement. A firm that manufacturing company that produces goods for its customer but generates pollution fall into this category. People suffering from the pollution but do not benefit from the products of the company (either as customers or as employees) can cite that particular market as a failure. Market failure may also result to good externalities. For example, when employers hire graduates but pay them less than their utility value, the employers are enjoying undue benefits known as ‘free ride’. In this case, employment is a state’s investment enjoyed by private businesses who did not contribute to the costs of education. This is not fair, and results to inefficiencies. The last common cause of market failure lies in the nature of goods. Public goods are those that non-exclusive and non-rival: non-exclusive in the sense that all people, regardless of their contribution, enjoy the benefits of those goods, and non-rival in the fact that other people’s consumption do not prevent one person from using them (Mankiw, 2009: 167). An excellent example is streetlights. In such a scenario, private businesses lack an appropriate mechanism of pricing for the consumers. The market thus fails, and government intervention is necessary. Choose ONE country United States of America Give examples of MF’s United States health care system is a market failure. According to research, the sector’s expenditures rose by 6.7% in 2006. In the report, Centers for Medicare and Medicaid Services reports an estimate of more than 2.1 trillion dollars, an equivalent of close to 7 thousand dollars for every American child, man, and woman. In comparison to the previous years, the cost of Medicare passed the 18.7% record because of privatized drug benefits. The report means that in 2006, 16% of the gross domestic product (GDP) goes to health care. This happens to be the biggest proportion dedicated to health care in the region, but the health care outcomes lags at number fourteen in comparisons to other countries. Below is a table indicating the performance of health care system among the first ranked fourteen countries. Infant Mortality Rate ( Read More