Benefits of free markets:
1. Economic efficiency: profits aim to maximise profits (by increasing level of output and decreasing level of input). Competition ensures that firms use the least cost and most economic methods of production – such as efficient use of labour and technology.
E.G. Fuel-efficient airlines – reducing plane weight e.g. smaller water tanks
2. Allocative efficiency: firms use scarce inputs to produce a combination of goods that maximises the welfare of the population. Resources go to firms that are most efficient at satisfying customers
E.G. If the population as a whole valued organic fruit and vegetables more highly than alternatives they would demonstrate this through the markets and firms would shift resources into production of organic produce
3. Consumer sovereignty: consumer drives productions. Firms that are sensitive to consumer demand will profit and grow.
4. Economic growth – resources will be directed away from firms that are inefficient and unprofitable to firms that are profitable and efficient
This generates economic growth – which leads to higher employment – leads to more consumption – leads to economic growth
Criticism of free markets
1. Free market benefit of Allocative efficient uses the perfect market assumption: that there are many buyers and sellers, no government intervention, homogenous products, freedom for entry and exit, perfect knowledge = not a realistic assumption.
Variations of these characteristics result in a less than perfect market and sub-optimal efficiency of resources use.
2. Consumer Sovereignty: Consumers are supposed to make rational decisions based on perfect knowledge – which they don’t have. Persuasive advertising influences consumers
3. Equity – consumers with more money have more power within the market place. Consumers with a low disposable income cannot access the goods and services that they need.
4. Public, merit and demerit goods
5. Externalities: firms do not have to take into account the externalities by their actions
Public Goods: Would not be provided in a free market, as suppliers cannot charge users.
Non-rival: one person using the good does not prevent another person from using the good
Non-excludable: once provided, cannot charge users for using it
e.g. street lighting, signage, clean beaches
Merit goods: seen as having a social benefits and probably would be underprovided in a free market.
- These goods tend to have short-term costs but have social and private benefits in the long run.
- People with a low disposable income – would be tempted not to purchase these which has a negative externality on the community in the long run.
Demerit goods: seen as having negative externalities and would probably be overprovided in a free market.
These goods have short-term private benefits but long-term social and private costs.
In a free market the organisation that produces these goods are not forced to rectify the externalities.
An example of market failure: Ticket scalpers
In a free unconstrained market, prices are set by the point where demand are supply are in equilibrium.
- The promoter would profit from selling tickets at this price.
- don’t know what the market is willing to pay
- Tickets for special events are often “under-priced” for social equity / political reasons.
Method and benefits of market intervention
- Central planning: production decisions are made by govt planning teams
- Mergers and Monopolies: Aim to protect consumers from high prices and reduced choice created by concentration of ownership (e.g. ACCC – in Australia)
- Laws, permits and control planning: used by all levels of govt to constrain a free market: