Colegiul Naţional ”Iulia Hasdeu”

Free Market Economy

-an introductory guide-

Coordinators Student
Simona Maior Alexandru Constantin Marin
Daiana Gutu

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 Table of Contents

Introduction ___________________________________________________________ 3

1. Definition ___________________________________________________________ 4
1.1. Principles 4
2. History _____________________________________________________________ 6

3. Advantages and disadvantages __________________________________________ 7

3.1 Advantages of free market system 7

3.2 The disadvantages of market system 7

4. Free Market Economy vs Command Economy ______________________________ 8

4.1. Similarities between Free Market Economy and Command Economy 9
4.2. Difference between Free Market Economy and Command Economy 9
4.3. Major Criticisms of Each System 10
5. Types of Economic Free Market Systems_________________________________ 10
5.1 Black Market (Underground economy) 11
5.1.1. Effects 11
5.1.2. Activities and Participants ____________________________ _12
6. Single Market __________________________________________________________13
6.1. EU Single Market 13
6.1.1. No more national barriers 14
6.1.2. A huge business opportunity 14
6.1.3. Some barriers remain 14
Conclusion ___________________________________________________________ 15

Bibliography _________________________________________________________ 16

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 Introduction

In a world where every aspect of life has become a business opportunity, it is

important to realize that economy is part of our modern daily lives. By understanding
the main concepts and principles of a free market economy, everyone can get valuable
insight into how foreign and domestic markets operate, which allows them to make reasoned
and rational choices for short-term and long-term financial benefits.

As we all know, money is the way we get the things we need and desire. We are surrounded
by goods wherever we go, and for example even an ordinary pen has a value, thus we need to
be aware of the importance of each economic decision.

In large and complex societies, it is easy to see that the task of coordinating the decisions
made by various economic actors—persons, households, businesses, financial institutions,
and governments—is itself a complex activity. If households want to purchase a quantity of a
certain good, how does that information get transmitted to the businesses that produce the
good? How do businesses communicate that they need more workers and materials in order
to produce it? What about when this good is not produced within a particular society? How
does that get communicated? These questions suggest that societies need to employ some
sort of mechanism to coordinate the allocation of resources by economic actors.

It’s easy for politicians to fear the Free Market, whether talking about the stock market, the
housing market, commodities market or any other venue where market forces determine the
value of things. They fear it because at its root they cannot control it. Politicians love control
and make no mistake, control is what they are about.

In other train of thoughts, getting insights of the Economic world can make you become an
important element for a society that needs such masterminds.

“Economy is the basis of society. When the economy is stable, society develops. The ideal
economy combines the spiritual and the material, and the best commodities to trade in are
sincerity and love. “
Morihei Ueshiba

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 1. Definition

The free market is a summary description of all voluntary exchanges that take place in a given
economic environment and are allocated through voluntary market transactions governed by the
interaction of supply and demand . 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.

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.

No modern country operates with complete 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 wh ere
property rights are well protected and capitalists have an incentive to pursue profits.

1.1. Principles
a) Supply:
The quantity of a commodity demanded depends on the price of that commodity and
potentially on many other factors, such as the prices of other co mmodities, the incomes
and preferences of consumers, and seasonal effects. In basic economic analysis, all
factors except the price of the commodity are often held constant; the analysis then
involves examining the relationship between various price levels and the maximum
quantity that would potentially be purchased by consumers at each of those prices. The
price-quantity combinations may be plotted on a curve, known as a demand curve, with
price represented on the vertical axis and quantity represented on the horizontal axis. A
demand curve is almost always downward-sloping, reflecting the willingness of
consumers to purchase more of the commodity at lower price levels. Any change in
non-price factors would cause a shift in the demand curve, whereas changes in the price
of the commodity can be traced along a fixed demand curve.

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b) Demand:
The quantity of a commodity that is supplied in the market depends not only on the
price obtainable for the commodity but also on potentially many other factors, such as
the prices of substitute products, the production technology, and the availability
and cost of labour and other factors of production. In basic economic analysis,
analyzing supply involves looking at the relationship between various prices and the
quantity potentially offered by producers at each price, again holding constant all other
factors that could influence the price. Those price-quantity combinations may be plotted
on a curve, known as a supply curve, with price represented on the vertical axis and
quantity represented on the horizontal axis. A supply curve is usually upward -sloping,
reflecting the willingness of producers to sell more of the commodity they produce in
a market with higher prices. Any change in non-price factors would cause a shift in the
supply curve, whereas changes in the price of the commodity can be traced along a
fixed supply curve.

c) Economic equilibrium
It is the function of a market to equate demand and supply through the price mechanism.
If buyers wish to purchase more of a good than is available at the prevailing price, they
will tend to bid the price up. If they wish to purchase less than is available at the
prevailing price, suppliers will bid prices down. Thus, there is a tendency to move
toward the equilibrium price. That tendency is known as the market mechanism, and
the resulting balance between supply and demand is called a market equilibrium.

d) Low barriers to entry

A free market does not require the existence of competition, however it does require a
framework that allows new market entrants. Hence, in the lack of coercive barriers,
and in markets with low entry cost it is generally understood that competition
flourishes in a free-market environment. It often suggests the presence of the profit
motive, although neither a profit motive or profit itself are necessary for a free
market. All modern free markets are understood to include entrepreneurs, both
individuals and businesses. Typically, a modern free market economy would include
other features, such as a stock exchange and a financial services sector, but they do
not define it.

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 2. History

The free-market system of voluntary economic trades, or the market economy, has existed in
different stages ever since human beings began trading with one another. Free markets emerged
as a natural process of social coordination, not unlike language. No single intellectual invented
voluntary exchange or private property rights; no government developed the concept or
implemented the first use of money as a means of exchange. The history of the market economy
is one of constant, unintentional (but not uninterrupted) progress rather than a series of
discoveries.

Even without money, human beings engaged in trade with one another. Evidence of this
stretches back far longer than written history can explain. Trade was barter-based initially, but
economic participants eventually realized that a medium of exchange would help facilitate
these beneficial transactions. This is because of a problem that economists call the double
coincidence of wants – if you have a chicken and want rice, you need to find a rice -carrying
chicken-wanter. The oldest medium of exchange was cattle, likely as far back as 9000 to 6000
B.C. It wasn't until 1000 B.C. that metallic coins were manufactured in China and became the
first known example of a good that functioned only as money.

While there is evidence of banking systems in early Mesopotamia, the concept wouldn't emerge
again until the 15th century in Europe. This did not occur without significant resistance; the
church initially condemned usury. Slowly thereafter, merchants and wealthy explorers began
to change the notions of business and entrepreneurship.

There are two pillars of the market economy: voluntary exchange and private property. It is
possible for trade to occur without one or the other, but that wouldn't be a market economy –
it would be a centralized one. Private property has existed long before written history, but
important intellectual arguments in favor of a private system of ownershi p of the means of
production would not be made until John Locke in the 17th and 18th centuries.

Most advances in free market practices have been met with resistance by central authority and
existing cultural elites. The natural tendency toward specialization and division of labour ran
counter to the caste system in feudal Europe and India. Mass production and factory work was
challenged by politically connected guildsmen. Technological change was famously attacked
by Luddites between 1811 and 1817. Karl Marx believed that the state should take away all
private ownership of the means of production.

Central authority and government planning have stood as the primary challengers to the market
economy throughout history. In contemporary language, this is often presented
as socialism versus capitalism. While technical distinctions can be drawn between common
interpretations of these words and their actual meanings, they represent the modern
manifestations of an age-old conflict: privately run, voluntary markets against state control.

Nearly all modern economists agree that the market economy is more productive and operates
more efficiently than centrally planned governments. Even so, there is still considerable debate
as to the correct balance between freedom and government control in economic affairs.

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 3. Advantages and disadvantages
Free Market Economy system automatically responds and adjusts to the people’s wants. As
we know, in a market system, the price of goods and services are determined by the forces
of demand and supply. If consumers want a particular good or a service, they simply
demand for it and the prices go up, which gives signal for the producers to produce more
of that good. If producers can produce the required amount of that particular good, the price
automatically comes down to normal. Likewise, if people no longer wants a particular good,
they simply stop demanding for it, so that it is no longer profitable for producers to produce
that good, so producers stop producing that good.

3.1. Advantages of free market system

a) Wider variety of goods and services
In a market system, producers compete with each other by offering wider variety of
goods, therefore consumers have more choice, this may even lead to lower prices.

b) Competition pushes businesses to be efficient:

Keeping costs down and production high.
The aim of firms in a market economy is to make as much profits as possible. In order
to do this, the firms need to be more efficient. Therefore they often use new and better
methods for production, this leads to lower costs and higher output.

c) Government does not have to take decisions on basic

economic questions
The market system relies on producers and consumers to decide on what, how and for
whom to produce. Therefore it does not require the government to employ a group of
people to take these decisions

3.2. The disadvantages of market system

a) Factors of Production is not employed if it is not profitable
In a market system, producers do not produce a good or a service if it is not profitable.
But sometimes it may be necessary to produce some goods even if it is not profitable.
Therefore Market system will fail in this aspect.

b) Market system may not produce certain goods and services

Private firms in a market system will not be willing to provide certain public goods like
street lights because it is almost impossible to charge any payment from the consumers.

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 c) Free market may encourage harmful goods
If there are people in the market who wish to buy dangerous goods like narcotic drugs,
the market will be ready to buy it since private firms will be willing to provide anything
that is profitable

d) Production may lead to negative externalities

When firms are always trying to maximize their profits, they may ignore external costs
like damages to the environment.

e) Free market economy may increase the gap between the rich
and the poor
When firms and individuals are able to produce and consume freely, it may make the
rich even richer because they have more decision making power, and the poor may
become poorer because they have less decision making power in the market. The market
system allocates more goods and services to those consumers who have more money
than others.

4. Free Market Economy vs Command Economy

If the whole financial management of country is controlled by the government, that economy
is identified as a command economy. The government has the power to control the pricing of
goods and services, quantity of output, distribution of goods, labors, etc. This is al so known as
a centralized economy. Depending on the criticality of the level of intervention, the government
may even assign people to respective jobs. The command economy has state -owned entities as
well as privately-owned entities, but both have a significant amount of control over government
rules and regulations. People in power, such as politicians, give orders to buyers, sellers, and
investors and the equilibrium will be determined by the government itself. The command
economy is a key feature of any communist society. Cuba, North Korea, and the former Soviet
Union are examples of countries that have command economies.

Market economy and command economy are completely mutual economic types. In free market
there’s no government intervention on economic activities; thus equilibrium is automatically
determined according to the intentions of the market players. In contrast, command economy
involves full government control over the entire economy. However, 100% government
intervention tends to discourage the private businesses; as a result, investors are also
discouraged to invest in the country. But a fair intervention is required to protect consumers
from market forces and to manage the societal impact on the free market. Therefore, a mixed
economy can be identified as the most effective type of economy for both personal and societal
wellbeing.

4.1. Similarities between Free Market Economy and

Command Economy

Both economies perform with general economic players such as producers and consumers,
goods and services, and money and labor; the aim of both is to produce goods and services that
are demanded by the citizens using the least amount of resources.

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4.2. Difference between Free Market Economy and
Command Economy
a) Decision Making
Free market Economy: Decision making is done by several individuals such as buyers,
sellers, intermediaries, etc.
Command Economy: The decision making is centralized and done by the authorized
government entities
b) Role of Government
Free market Economy: The government has little influence over the economic
activities.
Command Economy: The government has its full control over all the economic
activities.
c) Division of Labor
Free market Economy: The market is based on the division of labors.
Command Economy: No division of labor is involved.
d) Prices
Free market Economy: Price of goods and services is set by the supply and demand.
Command Economy: Prices are determined by the government decision makers.
e) Choice
Free market Economy: Choice of goods available to customers is higher.
Command Economy: Customers have less choice in command economy as what to
produce is purely a government decision.
f) Ownership
Free market Economy: Ownership of land and resources are with individuals or firms.
Command Economy: Land and other resources are owned by the government.
g) Quantity of Output
Free market Economy: Demand decides the quantity of output.
Command Economy: The government decides the quantity of output.
h) Distribution of Goods and Services
Free market Economy: Distribution of goods and services is decided by firms
themselves; so income distribution is not similar.
Command Economy: Distribution of goods and services is decided by the government; so equal
or fair enough income distribution practices.

4.3. Major Criticisms of Each System

Karl Marx, a German philosopher, argued that a market economy was inherently unequal and
unjust because power would be concentrated in the hands of the owners of capital. Marx is
credited with coining the term capitalism.

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John Maynard Keynes, an English economist, believed that pure market economies were unable
to effectively respond to major recessions and instead advocated for major government
intervention to regulate business cycles.

Ludwig von Mises, an Austrian economist, argued that command economies were untenable
and doomed to failure because no rational prices could emerge without competin g, private
ownership of the means of production. This would lead to necessarily massive shortages and
surpluses.

5. Types of Economic Free Market Systems

In market economies, there are a variety of different market systems that exist, depending on
the industry and the companies within that industry. It is important for small business owners
to understand what type of market system they are operating in when making pricing and
production decisions, or when determining whether to enter or leave a particular industry.

a) Perfect competition
Perfect competition is a market system characterized by many different buyers and
sellers. In the classic theoretical definition of perfect competition, there are an infinite
number of buyers and sellers. With so many market players, it is impossible for any one
participant to alter the prevailing price in the market. If they attempt to do so, buyers
and sellers have infinite alternatives to pursue.

b) Monopoly
A monopoly is the exact opposite form of market system as perfect competition. In a
pure monopoly, there is only one producer of a particular good or service, and
generally no reasonable substitute. In such a market system, the monopolist is able to
charge whatever price they wish due to the absence of competition, but their overall
revenue will be limited by the ability or willingness of customers to pay their price.

c) Oligopoly
An oligopoly is similar in many ways to a monopoly. The primary difference is th at
rather than having only one producer of a good or service, there are a handful of
producers, or at least a handful of producers that make up a dominant majority of the
production in the market system. While oligopolists do not have the same pricing powe r
as monopolists, it is possible, without diligent government regulation, that oligopolists
will collude with one another to set prices in the same way a monopolist would.

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 d) Monopolistic Competition
Monopolistic competition is a type of market system combining elements of a monopoly
and perfect competition. Like a perfectly competitive market system, there are
numerous competitors in the market. The difference is that each competitor is
sufficiently differentiated from the others that some can charge greate r prices than a
perfectly competitive firm. An example of monopolistic competition is the market for
music. While there are many artists, each artist is different and is not perfectly
substitutible with another artist.

e) Monopsony
Market systems are not only differentiated according to the number of suppliers in the
market. They may also be differentiated according to the number of buyers. Whereas a
perfectly competitive market theoretically has an infinite number of buyers and sellers,
a monopsony has only one buyer for a particular good or service, giving that buyer
significant power in determining the price of the products produced.

5.1. Black Market (Underground economy)

The underground economy refers to illegal economic activity. Transactions in the underground
economy are illegal either because the good or service being traded is itself illegal or because
an otherwise licit transaction does not comply with government reporting requirements. The
first category includes drugs and prostitution in most jurisdictions. The second includes
untaxed labor and sales, as well as smuggling goods to avoid duties. The underground economy
is also referred to as the shadow economy, black market (not gray market) and informal
economy.

It is difficult to gauge the size of underground economies, because they are by nature not
subject to government oversight and do not generate tax returns or show up in official statistics.
Discrepancies in these statistics can indicate the approximate size of informal economies,
however. For example, national income and national expenditure would in theory be identical,
if every transaction were fully visible to the people compiling the data. In practice, th ough,
expenditures exceed income, because income from an illegal transaction will not appear in the
data, but that money will show up in expenditures when it is used in a legal transaction. Along
the same lines, if electricity consumption grows faster than GDP, it might suggest that the
underground economy is growing at the formal economy's expense.

5.1.1. Effects
The underground economy can be benign or harmful, depending on the perspective and
economic context. In developing countries, the share of the informal economy is
relatively large, at around 36% in 2002-2003, according to Schneider, as opposed to
around 13% for developed countries. On the one hand, this is bad for developing-
country governments, which forgo tax revenue on a large share of transactions. That in
turn is bad for citizens, including participants in the informal economy, which do not
enjoy quality government services.

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On the other hand, keeping income that might otherwise be taxed can benefit
participants in the underground economy and boost economic activity overall through
added demand. That is especially true if tax revenues would just be siph oned off by
corrupt officials rather than funding the government – another aspect of the
underground economy.

5.1.2. Activities and Participants

A huge array of activities falls under the label "underground economy," and the list
varies depending on the laws of a given jurisdiction. In some countries, alcohol is
banned, while in others brewers, distillers and distributors operate openly. Drugs are
illegal in most places, but some U.S. states and a few countries have made the selling
cannabis legal. Tobacco is legal in New York City, but steep sin taxes mean that perhaps
60% of cigarettes in the city are sold illegally, as part of the underground economy.
Forced labor, the sex trade (where illegal) and human trafficking are part of the
underground economy. Black markets exist for copyrighted material, endangered
animals, products subject to sanctions or tariffs, antiquities and organs. In addition,
anyone who makes taxable income they do not then report to the tax authorities – even
if it's $50 for babysitting – is technically participating in the underground economy.

Participants in underground economies are a diverse bunch as well. They include

unregistered, untaxed food vendors on street corners. If a police officer
accepts bribes to allow those vendors to do business, the officer is then part of the
underground economy. So are elephant poachers, meth dealers, undocumented workers,
government ministers who hoard stolen cash in tax havens, entrepreneurs who
sell subsidized fuel across borders, graphic designers or handymen who do side-gigs
for cash, servers who underreport tips, and people-smugglers who ship refugees and
migrants across borders.

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 6. Single Market

A single market is a type of trade bloc in which most trade barriers have been removed
(for goods) with some common policies on product regulation, and freedom of movement of
the factors of production (capital and labour) and of enterprise and services.
The goal is that the movement of capital, labour, goods, and services between the members is
as easy as within them. The physical (borders), technical (standards) and fiscal (taxes) barriers
among the member states are removed to the maximum extent possible. These barriers obstruct
the freedom of movement of the four factors of production.

A common market is usually referred to as the first stage towards the creation of a single
market. It usually is built upon a free trade area with relatively free movement of capital and
of services, but not so advanced in reduction of the rest of the trade barriers.

A unified market is the last stage and ultimate goal of a single market. It requires the total free
movement of goods, services (including financial services), capital and people without regard
to national boundaries.

A single market has many benefits. With full freedom of movement for all the factors of
production between the member countries, the factors of production become more efficiently
allocated, further increasing productivity.

For both business within the market and consumers, a single market is a very competitive
environment, making the existence of monopolies more difficult. This means that inefficient
companies will suffer a loss of market share and may have to close down. However, efficient
firms can benefit from economies of scale, increased competitiveness and lower costs, as well
as expecting profitability to increase as a result. Consumers are benefited by the single market
in the sense that the competitive environment brings them cheaper products, more efficient
providers of products and also increased choice of products. What is more, businesses in
competition will innovate to create new products; another benefit for consumers.
Transition to a single market can have a negative impact on some sectors of a national economy
due to increased international competition. Enterprises that previously enjoyed national market
protection and national subsidy (and could therefore continue in business despite falling short
of international performance benchmarks) may struggle to survive against their more efficient
peers, even for its traditional markets. Ultimately, if the enterprise fails to improve its
organization and methods, it will fail. The consequence may be unemployment or migration.

6.1. EU Single Market

In the EU’s single market people, goods, services, and money can move around the EU as
freely as within a single country. Mutual recognition plays a central role in getting rid of
barriers to trade.
EU citizens can study, live, shop, work and retire in any EU country - and enjoy products from
all over Europe.

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 6.1.1. No more national barriers
To create this single market, hundreds of technical, legal and bureaucratic barriers to
free trade and free movement between the EU’s member countries have been abolished.
As a result, companies have expanded their operations. The competition has brought
prices down and given consumers more choice:

 Phone calls in Europe cost a fraction of what they did 10 years ago
 Many air fares have fallen significantly and new routes have opened up.
 Many homes and businesses can now choose their electricity and gas suppliers.
At the same time, with the help of Europe’s various competition and regulatory
authorities, the EU works to ensure that these greater freedoms don’t
undermine fairness, consumer protection or environmental sustainability.

6.1.2. A huge business opportunity

European businesses selling in the EU have unrestricted access to nearly 500 million
consumers, helping them to stay competitive. The single market is also attractive
to foreign investors.
Economic integration can also be a great advantage in times of recession, allowing EU
countries to continue trading with one another, rather than resorting to protectionist
measures that would worsen the crisis.

6.1.3. Some barriers remain

Many obstacles remain, however, in areas where integration is taking longer:

 fragmented national tax systems impede market integration and undermine efficiency
 separate national markets still exist for financial services, energy and transport
 e-commerce between EU countries has been slower to take off than at national level,
and rules, standards and practices vary considerably
 the services sector is lagging behind the goods markets (although it has been possible
since 2006 for companies to offer a range of services abroad from their home base)
 rules on the recognition of vocational qualifications need to be simplified to make it
easier for qualified workers to find a job in another EU country.

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 Conclusion

As we have seen in this project, nothing is random (as everything goes after strict rules)
and every aspect is in close relationship with others. One action has its immediate
response in one way or another.
We had the opportunity to analyze the similarities and differences between two different
economic systems as well as the advantages and disadvantages of a free market
economy.

We can't assume that markets always work well, or that the unintended consequences of buyers'
and sellers' actions will always serve the public interest. Even so, the consensus among
contemporary economists, regardless of political conviction, is that an imperfect market system
is far better than none at all. We do not live in a world that can be made perfect. Our task is to
choose among the imperfect alternatives, the achievable worlds.

The basic contours of the economic argument have been laid out. You have seen the beginnings
of what economists have to say about choice, the accounting of budget constraints under which
people make choices, the market as the coordinator of individual choices, and now some critical
questions about the role and effectiveness of the market.

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 Bibliography

https://ec.europa.eu
https://wikipedia.org
http://investopedia.com
http://pediaa.com
http://smallbusiness.chron.com
http://economicsguide.me

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