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What is a 'Free Market'

The free market is an economic system based on supply and demand with little or no government control. It is a summary description of all voluntary exchanges that take place in a given economic environment. Free markets are characterized by a spontaneous and decentralized order of arrangements through which individuals make economic decisions. Based on its political and legal rules, a country’s free market economy may range between very large or entirely black market.

BREAKING DOWN 'Free Market'

The term “free market” is sometimes used as a synonym for laissez-faire capitalism. When most people discuss the “free market,” they mean an economy with unobstructed competition and only private transactions between buyers and sellers. However, a more inclusive definition should include any voluntary economic activity so long as it is not controlled by coercive central authorities.

Using this description, laissez-faire capitalism and voluntary socialism are each examples of a free market, even though the latter includes common ownership of the means of production. The critical feature is the absence of coercive impositions or restrictions regarding economic activity. Coercion may take place in a free market if mutually agreed to in a voluntary contract, such as remedies enforced by tort law.

The Free Market's Connection With Capitalism and Individual Liberty

No modern country operates with completely uninhibited free markets. That said, the least restrictive markets tend to coincide with countries that value private property, capitalism and individual rights. This makes sense since political systems that shy away from regulations or subsidies for individual behavior necessarily interfere less with voluntary economic transactions. Additionally, free markets are more likely to grow and thrive in a system where property rights are well protected and capitalists have an incentive to pursue profits.

Free Markets and Financial Markets

In free markets, a financial market develops to facilitate financing needs for those who cannot or do not want to self-finance. For example, some individuals or businesses specialize in acquiring savings by consistently not consuming all of their present wealth. Others specialize in deploying savings in pursuit of entrepreneurial activity, such as starting or expanding a business. These actors can benefit from trading financial securities.

For example, savers can purchase bonds and trade their present savings to entrepreneurs for the promise of future savings plus remuneration, or interest. With stocks, savings are traded for an ownership claim on future earnings. There are no modern examples of purely free financial markets.

Common Constraints on the Free Market

All constraints on the free market use implicit or explicit threats of force. Common examples include: prohibition of specific exchanges, taxation, regulations, mandates on specific terms within an exchange, licensing requirements, fixed exchange rates, competition from publicly provided services, price controls and quotas on production, purchases of goods or employee hiring practices.

Even when free market behavior is regulated, voluntary exchanges may still take place in spite of government prohibitions. Such exchanges take place in the so-called “black market,” which may be considered an underground version of the free market. Competition is difficult and the price system is much less effective in a black market, so monopolistic or oligopolistic behavior is likely.

Free Market Concepts

In order to understand the free market, it’s important to examine the concepts that help shape it. Here are two: 

  1. Supply and demand is the economic model of how prices are determined in a market. Demand for goods refers to pressure in the market from people trying to buy it. Consumers will have a maximum price they are willing to pay, as opposed to the minimum price sellers have in order to offer it. Prices and the number of items are adjusted based on the economic conditions at the time. In a free market, anyone has the freedom to enter, leave and take part in the market as they wish.  
  2. A free market should also offer low barriers to entry. A free market does not need competition in order to exist, but it should allow the chance for other players to join in. That means that the lack of barriers with little or no entry costs helps competition thrive in a free market economy. 

Principles of a Free Market

Although there is no one set of variables that define a free market, there is a generally accepted set of measures that help determine just how free a market economy can be. These variables can be divided into the following groups: 

  • Trade policy
  • Government intervention
  • Monetary policy
  • Capital and foreign investment flows
  • Banking and finance
  • Wages and prices
  • Regulation

These are some of the principles that helped move the United States toward a free market economy. 

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