What is a Free Market Economy?

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Definition:

A free market economy means that people (and companies) buy and sell with a minimum of government regulation.

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🤔Understanding a free market economy

A free market economy is one in which the operation of the economy is mostly left in private hands, with a minimum of government regulation restricting the buying and selling of goods and services. The United States is generally considered to have a free market economy. In concept, a free market economy is self-regulating and benefits everyone. Supply and demand should balance as businesspeople chose to create and sell items with the highest demand. Consumers get what they want as suppliers compete to fill the needs at prices the consumers want. Employees with the best skills should command the highest wages as companies compete for the best workers.

Example

Imagine you and your friends discovered a new island and founded a new country. Your new economy is based on each of you using your strengths. Your best friend might make amazing coconut pie from those coconuts. Other friends might dig wells for water or raise the native goats for milk and meat. Each of you would find a demand to fill with your strengths, and you would trade those products or services to get the products and services you need. There would be no government interference or regulation needed for everyone to survive and thrive.

Takeaway

A free market economy is like a perpetual motion machine...

In theory, a perpetual motion machine, once started, stays in motion forever — with no friction or loss of energy ever occurring. It is perfect. Of course, no such machine exists. Similarly, a perfectly free market can exist in theory, but doesn’t exist in the real world. Some friction (market failure) enters the picture somewhere, requiring at least some government intervention. Some economies are much closer to a fully free market than others — just as some machines are more efficient than others.

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What is a free market?

The free market, in ordinary usage, means a market or economy in which economic actors are able to act freely — Buyers and sellers have no restrictions on their activities and can make any exchanges that the parties involved find mutually beneficial.

The free market is also sometimes used as a synonym for laissez-faire capitalism. However, it would be fair to apply the term “free market” as well to other purely voluntary forms of economic activity, such as voluntary socialism (e.g. a kibbutz).

The key factor in whether or not something is a free market (or can be described as free-market) is the absence of coercion — profit does not have to be the sole motivator or end goal.

Is a free market the same as free trade?

Free markets and free market economies are not the same as free trade. Free trade happens when two countries have a legal agreement (like a treaty) that allows trade across borders without any tariffs, import restrictions, currency exchange manipulations, quotas, or other regulations on the trade itself.

Because free trade only affects the trade of goods across borders and does not negate other regulations on the buying and selling of those goods once they are in-country, it is not the same as a free market.

What are the characteristics of a free market economy?

Free markets and free market economies are fueled by personal choice and economic freedoms. Personal wants (products, profit, or personal agendas) are the engine that creates needs (demand) that then trigger others to produce products or services to feed those needs (supply).

Free enterprise has minimal governmental interference and regulates itself — Just as evolution is self-regulating to the survival of the fittest. Adam Smith, one of the fathers of the idea of free markets, described the self-regulating nature of a free market economy as an “invisible hand” that naturally balances economic activity.

How does a free market economy work?

The concept of laissez-faire economics that free market economies come from is based on the idea that each person, in the process is striving to fill their own needs, will guide and self-regulate the market without the need for outside government regulations.

Laissez-faire is French for “let do” and describes the idea of letting people do what they want. In a free market economy, not only do workers compete with each other for jobs, but employers compete for the best workers.

A free market does not mean that there is no government at all. Free markets generally require a government to enforce the “rules of the road” — to provide for courts, police, etc. Contracts between private parties are meaningless if there is no one to enforce them; and individuals aren’t free if someone stronger can come along and take their property by force.

Countries have more or less free market economies on a spectrum, with the United States being at the relatively free end of the spectrum — Extremely controlled economies, such as North Korea’s, exist at the other end of the spectrum.

What countries have a free market economy?

No country has a fully free market economy. Countries’ economies exist on a spectrum of how free-market they are. The United States is one of the largest free market economies — though it certainly has a number of regulations, businesses and individuals are generally free to do business as they see fit.

Rankings of economic freedom vary depending on who is doing the ranking, but some economies generally considered free-market include: Hong Kong, Singapore, New Zealand, Australia, Switzerland, the United Kingdom, Canada, and Ireland.

Some of the world’s least-free economies include: North Korea, Cuba, Venezuela, and Eritrea.

Does the US have a free market economy?

Yes, the United States economy has regulations in certain industries — for example, the pharmaceutical industry has many rules — but the American economy is mostly open and based on personal decisions. It is widely considered a free-market economy, and it is the largest free-market economy in the world.

What are the pros and cons of a free market economy?

For example, private property rights might be an advantage to some, but others might believe the state should have control over some property for the good of the country.

However, there are pros and cons of a free market economy that are more cut and dry.

Pros: Some of the advantages of a free market economy are innovation, lower cost of goods, ease of starting a business, and open competition.

In a free market economy, innovation flourishes because it is not restricted in general, and the rewards of innovation can be significant. This flourishing innovation leads to quick advancements in many fields, which benefits both the innovator and those who use those advances later.

Another advantage is the low cost of goods. Since a free market economy allows buyers and sellers to negotiate price freely, most products are naturally pushed to a lower price due to competition in the absence of government regulations artificially inflating prices. This competition is possible because of the ease of starting a business. A final advantage is the lack of state-mandated monopolies. Many real-world economies have specific industries where the government backs (or owns) a monopoly. These are often infrastructure type industries such as communications or medical care where the government is worried about instability should a company fail. In a free market, these are rare, which opens up the competition.

Cons: The downsides to a free market economy mostly come in where self-interest and real-world events clash with the theory of a self-regulating market. Survival of the fittest isn’t always a pretty picture and doesn’t worry about those left behind. Society, in general, wants some protections for those who would otherwise be left behind. This conflict often leads to calls for regulations and ultimately makes a real-world free market economy practically impossible.

Lack of consumer protections, environmental abuses, labor abuses, limited product choice, the possibility of catastrophic business failure in a vital industry, and conflicting self-interests are all downsides to a free market economy.

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New customers need to sign up, get approved, and link their bank account. The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. Stock rewards not claimed within 60 days may expire. See full terms and conditions at rbnhd.co/freestock. Securities trading is offered through Robinhood Financial LLC.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Options trading entails significant risk and is not appropriate for all customers. Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount.

Commission-free trading of stocks, ETFs and options refers to $0 commissions for Robinhood Financial self-directed individual cash or margin brokerage accounts that trade U.S. listed securities and certain OTC securities electronically. Keep in mind, other fees such as trading (non-commission) fees, Gold subscription fees, wire transfer fees, and paper statement fees may apply to your brokerage account. Check out Robinhood Financial’s Fee Schedule for details.

Brokerage services are offered through Robinhood Financial LLC, (RHF) a registered broker dealer (member SIPC) and clearing services through Robinhood Securities, LLC, (RHS) a registered broker dealer (member SIPC). Cryptocurrency services are offered through Robinhood Crypto, LLC (RHC) (NMLS ID: 1702840). Robinhood Crypto is licensed to engage in virtual currency business activity by the New York State Department of Financial Services. The Robinhood spending account is offered through Robinhood Money, LLC (RHY) (NMLS ID: 1990968), a licensed money transmitter. A list of our licenses has more information. The Robinhood Cash Card is a prepaid card issued by Sutton Bank, Member FDIC, pursuant to a license from Mastercard®. Mastercard and the circles design are registered trademarks of Mastercard International Incorporated. RHF, RHY, RHC and RHS are affiliated entities and wholly owned subsidiaries of Robinhood Markets, Inc. RHF, RHY, RHC and RHS are not banks. Products offered by RHF are not FDIC insured and involve risk, including possible loss of principal. RHC is not a member of FINRA and accounts are not FDIC insured or protected by SIPC. RHY is not a member of FINRA, and products are not subject to SIPC protection, but funds held in the Robinhood spending account and Robinhood Cash Card account may be eligible for FDIC pass-through insurance (review the Robinhood Cash Card Agreement and the Robinhood Spending Account Agreement).

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