Free Market Economy – Meaning, Features, Advantages, and Limitations

What is a Free Market Economy?

A free market economy is an economy in which the driving forces are the demand and supply in the market. Unlike centrally-planned economies or command economies, it is unregulated and free from government controls and directions. The market participants decide the production and resource allocation, distribution, and pricing of the goods and services in the economy. Anyone with a willingness to buy a good or a service and the ability to pay for it can engage in trade.

A free market economy does not exist in reality. Every economy in the world faces some restriction or control from the government. The government implements taxes, quality controls, quotas, tariffs, etc., and controls the outcome of the market. Hence, economies are mostly a mix of a free market economy and a centrally-planned economy.

Features of a Free Market Economy

Truest form of Capitalism

A free market economy is the truest form of Capitalism that can exist. Profit-making is the driving force that controls all the production, resource allocation, and supply in the economy. The demand-side factors push businesses to be as efficient as possible.

No Government Control

As the name suggests, a free market economy is free from all governmental intervention and control. The markets enjoy complete autonomy. The government does not have the power to dictate what to produce, what resources to use, where to supply, and at what prices to supply.

Demand and Supply Decide the Price

Price is decided in a free market economy by the forces of demand and supply in the market. Prices go up when the demand goes up, the supply being the same in the short run. Similarly, prices go down when the demand for the product or service falls, the supply being the same as before. Prices return to normal when the supply matches the demand.

Ownership of Resources

The private sector owns the majority of resources in such an economy. Production, resource allocation, supply, and logistics- everything is in the hands of the private sector.

Complete Freedom

Complete freedom is one of the basic features of a free market economy. The market participants enjoy complete autonomy. They are free to decide what to buy and sell at the price of their choice.

Advantages of Free Market Economy

Fair and Efficient Pricing

Some may feel that suppliers make excessive profits in a free market economy because there is no government control. However, this is not the case. Whenever a supplier increases the prices for his products, the demand adjusts itself and falls. This forces the supplier to reduce the price up to the equilibrium price where demand is equal to the supply.

There is another factor that results in efficient pricing in such markets. The entry of new suppliers is easy and open as it is a free market. If there is a scope of high margin in any product category, new entrants will jump in. They will start selling the product at a price a bit lower than the prevailing market price in order to capture the market. The first seller will respond and match the prices of the new entrant to win back his customers. This process will continue until the price reaches its optimum level, and there is no scope left for further reduction in price. Therefore, this system results in fair and efficient pricing of products.

Promotes Innovation

A free market economy promotes innovation and motivates the producers to innovate constantly. They are encouraged to bring in new products and launches since there is no restriction and interference by the government. The markets are profit-driven, and suppliers try to supply the best products.

Also consumers also decide freely which product they want and which to reject. There is no government pressure to buy a particular product or service.

Limitations of Free Market Economy

Along with advantages come disadvantages as well. Let us look at the limitations of a free market economy.

Risk of High Supply Prices

There is always a risk of high supply prices in a free market economy. Producers may collide with each other and decide to maintain a high price for a product or service across the market. This usually happens in the case of an oligopolistic market.

Sometimes, a producer may charge high prices for his product because he knows that it is not possible for any other supplier to provide that product within a short time span.

Sale of Harmful and Dangerous Goods

Such a system promotes the manufacturing and sale of harmful and dangerous goods in an economy. In the absence of government control, suppliers can engage in the trade of harmful goods such as drugs, dangerous chemicals, and weapons. This can be detrimental to any society.

Conclusion

A free market economy can be a dream come true for the lovers of Capitalism. Such markets give the upper hand to individuals rather than the government and promote freedom of choice. Profit motive pushes one and all to give their best, helping to maximize market efficiency.

However, every coin has two sides. Any economy requires some guidance and control by the government to move in the right direction. Tariffs help to protect the domestic market players by making the imports expensive. The governments set quotas to restrict the trade of selective items for the betterment of the home market. Taxes and regulatory controls are essential to deter trade in harmful goods and services. This is why a free market economy is hardly a reality in the present world. The majority of the countries opt for mixed economies, which have the features of both a free market economy and a controlled economy.  



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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