Why and How Free Markets Work

The economy is the production and exchange of goods and services. When much is being produced and being widely distributed, we have prosperity.  The 1930s was a time of deprivation and not prosperity. People went hungry in the modern English speaking world. Yet there were bumper harvests. The problem was that the distribution system broke down. Prosperity requires both production AND distribution.

The greatest prosperity happens with a free market. “Free” because it is free from legislative interference. A free market is built on certain basic mechanisms that work together to result in prosperity. These include property rights, voluntary exchanges, division of labor, price system, and profit system.

Property rights and a right to profits provide incentives to produce. What to produce is determined by prices. Prices are determined by what consumers are willing to pay. Producers may set initial prices, but if there are no buyers, the price will change to match consumers’ expectations. The best satisfaction of consumer need happens when producers produce to meet those needs, and it is prices --- what people are willing to pay --- that signals the extent of the need. As soon as governments interfere with support legislation such as minimum wages and price supports, price signals are distorted with a corresponding shift in production that will no longer allocate resources to meeting consumer needs as effectively as would have been the case with no such legislation.  I well remember walking into a department store in a communist country years ago and seeing racks of fur coats but very little of what people really wanted. This was the result of price interference.

Voluntary exchanges means that nobody is forced to sell or compelled to buy. And if someone has a willing buyer or a willing seller, he can transact with that person at any price upon which both are agreed.

Division of labor refers to workers doing what they are good at doing. This happens in a free market. A worker with a strong and needed skill is encouraged by the pricing of that skill to apply it and to use his earnings to hire someone to do those things at which he is not so adept. If you are a skilled surgeon but a bungling mechanic, you are better off doing surgeries and hiring a mechanic to fix your car than you are fixing that car yourself. This aspect of free markets is a way to ensure that people do what they are effective and efficient at doing, and this maximizes the effective use of resources: it mitigates waste and it maximizes production of what people want.