Question

In the absence of direct externalities, common property and public goods, discuss the optimality of free markets.

Answer 1

In its purest form, a free market economy is when the allocation of resources is determined by supply and demand, without any government intervention.

Supporters of a free market economy claim that the system has the following advantages:

• Everybody has the right to choose what to produce or consumer, so political and civil freedom.
• It contributes to economic growth and transparency.
• It ensures competitive markets.
• Consumers' voices are heard in that their decisions determine what products or services are in demand.
• Supply and demand create competition, which helps ensure that the best goods or services are provided to consumers at a lower price.

Critics of a free market economy claim the following disadvantages to this system:

• A competitive environment creates an atmosphere of survival of the fittest. This causes many businesses to disregard the safety of the general public to increase the bottom line.
• Wealth is not distributed equally – a small percentage of society has the wealth while the majority lives in poverty.
• There is no economic stability because greed and overproduction cause the economy to have wild swings ranging from times of robust growth to cataclysmic recessions.
• Assumptions required for free markets to operate well are inconsistent with reality such as the myth of perfect and symmetric information, rational actors, and costless transactions.