Chapter 2.2: The Free Market

Markets exist so that people can exchange what they have for what they want. A free

market is a self-regulating economic system directed by individuals acting in their own self-

interest.

Markets and Why They Exist

• Market: an arrangement that allows buyers and sellers to exchange things (examples: farmer’s market, stores, the NY Stock Exchange, a babysitting flier)

• They exist because no one is self-sufficient; none of us produces all we require to satisfy our needs and wants

• They allow us to exchange the things we have for the things we want

Specialization

• Each of us produces just one or a few products; specialization is the concentration of the productive efforts of individuals and firms on a limited number of activities. This leads to efficient use of resources.

• This leads to buying and selling; we need markets to sell what we have and buy what we want. If everyone was self-sufficient there would be no need for a market of any kind.

Free Market Economy

• Economic systems that are based on voluntary exchanges in markets

• Individuals and businesses use markets to exchange money and products

• The main players in the free market economy are households (people who live in the same residence) and firms (organizations that use resources to produce a product which it then sells)

• Firms transform “inputs”/factors of production into “outputs”/products

Continued

• Factor Market: the arena of exchange where firms purchase factors of production from households to try to make a profit (financial gain made in a transaction)

• Product Market: the market in which households purchase the goods and services firms produce

Adam Smith

• Scottish social philosopher who published The Wealth of Nations in 1776 where he described how the market functions

• He said that the buyer and seller only consider their own self-interest, or personal gain, which is the motivating force behind a free market

Competition

• Incentive: the hope of reward or the fear of punishment that encourages a person to behave in a certain way

• Adam Smith observed that people and consumers respond predictably to both positive and negative incentives

• Competition: the struggle among producers for the dollars of consumers

“The Invisible Hand”

• Term economists use to describe the self-regulating nature of the market place

• Our market place mostly runs itself without any central plan or direction; self-interest causes us to buy certain things and firms continue to produce them, while competition causes more production while preventing firms from increasing prices

Advantages of the Free Market

• The free market meets the following economic goals we learned about in 2.1: – Economic Efficiency: the free market is self regulating

and responds efficiently to changes– Economic Freedom: free markets have the highest

degree of freedom of any system, from workers to firms to individuals

– Economic Growth: Competition encourages innovation, which encourages growth

– Additional Goals: Offers a wider variety of goods and services than any other system. Consumers having the power to decide what gets produced is consumer sovereignty