Free Market Economy Concept - Example

Free Market Economy Concept Name Course Course Code Instructor’s Name 3rd March, 2012. Free market economy concept Introduction Economists have come up with three market systems through which resources are allocated in the economy. The systems are the free market system, the planned system and the mixed economy. The free market system is also known as the laissez faire or the capitalistic economy. The planned economy is also referred to as governmental, communal or socialist economy. The mixed economy refers to the mixture of both free market features and planned market features (Taylor & Weerapana 2007, pg 42). A free market system is an economic system where allocation of resources by the market players are as guided by the market forces; demand and supply while a planned economy decisions regarding resource allocations are governed or guided by a governmental body. The difference between the two systems is the government intervention. Free market concept and the market forces; demand and supply The free market economy is owned by individuals who have sole possession of the production, resources and are guided by the demand and the supply forces with no government intervention (Taylor & Weerapana 2007, pg 39). In Economics, the term demand refers to the amount of a commodity that buyers are willing and able to buy at a particular price in a particular period of time. Therefore, demand can be said to have four aspects in it; willingness, ability, price and time. On the other hand, the term supply refers to the amount of a commodity sellers are willing and able to offer for sale in the market at a particular price in a particular period of time. The law of demand states that for a normal commodity, an increase in price of a commodity will result to a decline in the quantity demanded with the vice versa also being true. The price- quantity relation in demand is expressed in the graph below. (Taylor & Weerapana 2007, pg 54) The law of supply states that an increase in price will cause an increase in the amount supplied with the vice versa being also true. The statement can be represented on a graph as follows. (Taylor & Weerapana 2007, pg 60) Shift of supply and demand curves in a free economy However, price is not the only factor that affects demand and supply. Other factors that affect demand of a commodity are; price of other related products; complementary or substitutes, the income of the consumers, tastes and preferences of the consumers, levels of advertisements and government policies among others. These factors will cause a shift in the demand and supply curves rather than a movement which is caused by price only (Taylor & Weerapana 2007, pg 54-57). The shift in the demand and supply curve can be illustrated in the diagram below. Price Supply decrease Supply Supply increase Demand increase Decrease Demand (Taylor & Weerapana 2007, pg 70) A decrease, in demand is reflected by a shift of the demand curve to the left while an increase shifts the demand curve to the right. A decrease in supply shifts the supply curve to left while an increase shifts the curve to the right. A decrease in the price of a commodity’s complementary will cause an increase in the demand of the commodity while a decrease in the price of a substitute will cause a decrease in the amount demanded of the commodity. Positive taste and preferences and increase in the consumer’s income as well as consumer population will cause an increase in the commodities demand. The vice versa is also true. Negative government policies which refer to taxation and price policies among others will adversely affect the commodities demand. On the other hand, factors that affect a commodity’s supply apart from its own price are prices of related products; complementary and substitutes, cost of production, technological factors and government policies (Taylor & Weerapana 2007, pg 61- 63). However, in a free market economy, government intervention as a factor affecting demand and supply is not accounted for. An increase in the price of a commodity’s substitute will result to a decline in the quantity supplied thus the supply curve will shift to the left while an increase in the price of a commodity’s complementary will result to an increase in the quantity supplied of the commodity. The vice versa is also true. Market forces guidelines is the major feature of the free market economy. Another feature of the free market economy is the ownership of private properties hence full ownership of the property proceeds. Individuals are fully entitled to enjoy the proceeds that are generated by the properties. In addition, the market is characterized by free entry and exit. Consequently, the market obtains a large number of sellers as well as buyer hence reflecting a lot of competition in the market. The high competition in the market leads to production of quality goods and services since the market serve the customers with a range of varieties (Taylor & Weerapana 2007, pg 184- 188). On the other hand, lack of government intervention means that there are no taxes, no quotas or subsidies, no price controls, no import or export duties and no licensing fees among other government forms of intervention. The market system is in additional characterized with no wastage. This is because the market forces; demand and supply tend to match hence reducing cases of over or under production. The system can therefore be said to be flexible since demand changes are well responded to by the suppliers. This is evidenced by the market’s point of equilibrium where the amount demanded matches with the amount supplied (Taylor & Weerapana 2007, pg 65-66). The point of equilibrium, excess production (excess supply) and underproduction (excess demand) is illustrated in the diagram below. (Taylor & Weerapana 2007, pg 70) The demand and supply forces in a free economy will have their curves move to the right and to the left due to the factors affecting demand and supply until an equilibrium point is arrived at. The equilibrium point will consequently set the equilibrium price of a product at a particular period of time. Advantages of the free market economy The free market economy has been analyzed and exhibited a bunch of advantages. Among other advantages, lack of government intervention results to high production of goods and services. This is because there is free entry and exit of the market. This is evidenced by the lack of licensing fees among other government formalities in entry and running of the market. The free entry in the market results to increased buyers and sellers hence competition which leads to production of quality goods and services (Taylor & Weerapana 2007, pg 16). The free market entry leads to increased employment levels which consequently raises the living standards of individuals in the economy. In addition, the competition in the free market leads to invention and innovation of new products (Taylor & Weerapana 2007, pg 570). Individuals in the market are forced to invent new products due to the high competition in market. Consequently, consumers are provided with a range of varieties. The consumer sovereignty is therefore maximized in the free market system since they are able to choose among the varieties in regard to their tastes and preferences. The forces of demand and supply dominate the market therefore limits wastages in the economy. In reference to the point of equilibrium, the market players are able to limit wastages by matching the quantity supplied against the quantity demanded. Consequently, the forces dominance results into low or no excess demand and low or no excess suppliers. Producers do not overproduce and neither is there an occurrence of underproduction (Taylor & Weerapana 2007, pg 15 - 16). This saves on resources used in production and at the same time maintains stability in the market. Moreover, firms engage in realistic projects of production such that they undertake to produce profit realizing products only which saves on resources. Disadvantages of the free market economy In the free market system, some essential goods and services are not convenient for market forces regulation. Essential services such as education and health are provided but at a very high cost such that only a few individuals can afford them (Taylor & Weerapana 2007, pg 81). Since free market system means low or no government intervention in the economy, public services offered by the public such as defense and street lighting would not be provided. Government intervention in the economy is justified by various reasons. One reason for government intervention is the consumer protection. Consumers in a free market are exposed to exploitation by the private firms. One form of exploitation is on the monopolistic power of a seller. A seller with monopoly powers will exploit the consumers since the market forces no longer adversely affect the commodity’s price but the price is fixed by the monopoly. The monopoly will therefore tend to charge high even on essential goods and services. The monopoly power is however obtained through unethical behaviors in the economy where buyers will commit social economic crimes to drive others out of the market (Taylor & Weerapana 2007, pg 270). In addition, consumers will be prone to harmful products in a free market system as there are no government regulation on health standards and the like. Government intervention is justified on the basis of providing essential goods and services where private investors are not willing. Concurrently, a free market economy is characterized by unfair distribution of resources (Taylor & Weerapana 2007, pg 84). In the planned or the socialist economy system, the government intervenes through various ways in the setting and controlling of the prices. The government uses the price ceilings and the price floors in price regulation. The price ceiling is set below the equilibrium price set by the market forces such that firms are given the maximum price of their commodities which is below the equilibrium price. The price ceilings results to low productions in the economy as firms either quit production or look for another option. Consequently, this creates or reduces unemployment opportunities. In addition, price ceilings leads to emerging of illegal black markets which operate beyond the price ceiling. On the other hand, the government sets price floors or minimum price on some products. The price floor is usually above the equilibrium price. Price floors are used to get excess supplies which are used during shortage times (Taylor & Weerapana 2007, pg 81-85). At times, minimum prices are connected with the regulations of harmful products such as tobacco products to decrease their demands. Concurrently, the price floors are used to set minimum wages in such industries. The diagram below illustrates the price floor and the price ceiling. Price floors Equilibrium Price Equilibrium point Price ceiling Equilibrium quantity (Quantity demanded/ Quantity supplied) (Taylor & Weerapana 2007, pg 84) In reference to free market features, advantages and disadvantages in connection with need for government intervention, a mixed economy would do well to an economy. Bibliography Taylor J. & Weerapana A. 2007. Economics. Boston. South-Western college publishers. http://www.amazon.com/Economics-John-B-Taylor/dp/0618967613/ref=sr_1_1?s=books&ie=UTF8&qid=1330761599&sr=1-1#reader_0618967613 Read More