The free market economy and how it operates

In this task I will be talking about the free market economy and how it operates but also how the setting of price sends ‘signals’ within this system. I will be looking at how markets nevertheless fail to operate efficiently and why the UK government might seek to control the prices of products or services in the economy and their motives for doing so, but also evaluating the degree in which the legal system of the UK might act to avoid exploitation of consumers in price setting or any other ways. At the end I will bring all my information together in a conclusion.

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A free market economy is an economy in which an allocation for resources is determined only by their supply and demand they have. There is no intervention of the superior powers such as government control in any of their activities in the market and that way the free market has idealized form from which the market economy has buyers and sellers who are allowed to transact freely. The transactions are based on mutual agreement on price without the state involvement on the form of taxes, subsidies or regulation. However based on the values and methods of the economy, there were several models developed so people can understand and analyse the economic system.

Here are a few of the models with explanations of what the market economy has:

Drivers, in which a market economy gain vibrancy from private enterprises in which they invest into developing the facilities they have to provide certain products and services in response to their consumer demands and what they aquire.

Distinctive Features are what market econmies have and they can be decentralised, supple, realistic, and unpredictible in nature. They are not therefore managed by government ministry. An econmists called Adam Smith had a unique describing for market forces as “invisible hand” this is what guides market economies. The “invisible hand represents the responsibility of the production of goods and services, and what they are priced at, in the market economy. However this would guide consumers to participate and trade goods in the market in the most mutual beneficial behaviour.

Consumer freedom states that the market economy is practical but also the elementary theory has an important role in which it plays. Consumers like to pick different products and services which suit them in the market economy, therefore giving the producers to expand or start a business on conditions that suit him but also any investors if they are sharing. In this the worker can choose what they do such as how they do their job, join in unions or organisations as long as they are permitted by the law or change who they employ.

The price signals are messages which are sent to the consumers and producers in the way in which price is charged for commodity, this can be seen as an indication for producers to increase their supplies and/or consumers to reduce demand.

The free price system/mechanisms are the econmomic system where prices are set by interchange, depending on supply and demand. The resulting prices therefore are understood as signals which the consumer and producer communicate to expand the production to meet customer demands.

Markets failure is a theory in which the allocation of goods and services by a free market are not efficient and if the price signals do not work properly then this can lead to market failure. There are businesses in the private sector which can also not be able to provide public goods which leads to market failure and also markets can fail as they do not bring in the economic efficiency to operate.

When markets fail the results are productive efficiency in which the business is not maximising the output from set factor input. The problem occurs to this as it loses the output of inefficient production which is used to satisfy more needs and wants. Secondly is an allocative efficiency in which the resources are misallocated and producing the goods are no longer needed by consumers. This problem is due to making better use of the resources to produce goods that consumers value highly.

Public goods have an affect on this as they are not being provided by the free market due to two of their characteristics in non excludability where they can provide a good or service to a person without it being available to other to have as well. The second is non rivalry where consumptions of good or service will not prevent others to have, if a person has it and other example such as street lighting, police services, air defence system, roads/motorways and public parks and beaches. As they are in the private sector they can not provide public goods. There public goods that are available, no one wants them in the free market sector as everyone will benefit, however in-order to have them you have to pay for them.

Externalities are a cost or benefit, which is not transmitted through prices and there are two of these a positive and a negative externality. They can cause a market failure if the price mechanism is not taken into account the social costs and benefits of production and consumption.

A benefit is a positive externality, for example education as it “creates a positive externality because more educated people are less likely to engage in violent crime, which makes everyone in the community, even people who are not well educated, better off”.

The opposite is an external benefit and a cost is called a negative externality or external cost, for example alcohol can lead to drink driving accidents which can kill or injure pedestrians or other drivers on the road.

The government plays a small role in the driving of market economies, they have intervention such as subsidies of industry, license quotas and the fixing of commodities is minimal.

Here are the main roles the government usually plays are:

defining and enforcing property rights

defining and enforcing a system of contract law

prohibiting and punishing fraud

prohibiting and punishing unsafe practices

The governments main reasons are to intervene is to correct the market failure, achieve more equitable distribution of income and wealth and improve the performance of the economy to where it was before the failure.

The government will then try to replace the free market by supplying goods and service themselves so the market does not fail and one way in which they can do this, is through the use of taxes and subsidies. Many economists use these as they achieve greater social efficiency. When the market is imperfect, the social efficiency will not be achieved. Government controls prices by taxing goods or services where the market is producing too much and uses subsidies where it is producing too little for consumers.

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The UK government may want to control the prices of products and services in the economy as they want customers to come in and buy them. If the prices are high not many people would buy the products they offer, due to only spending their money on necessity goods as recessions has hit them and they can not afford to buy expensive products on offer.

The motive in which the government stops negative externalities is by putting tax on the product to increase market equilibrium. For example smoking as it affects people health and the price businesses set does not take into account these externalities.

The goods that have positive externalities will subsidise them to a lower price for example education, as it is an undersupplied good as people don’t see it as a benefit.

The market economy operates highly with regulations and has government regulators to enforce price control in most of what we use in everyday life such as telecommunications, gas, electricity and transport.

The UK legal system puts into place certain laws to avoid exploitation of consumers in any certain ways such as the government legislation and regulation. The parliament can pass a law down on to companies such as selling cigarettes and alcohol to underage kids or banning smoking in certain areas of the workplace. The competition act can be used for price fixing cartels or other anti competitive behaviour that occurs in markets by firms and employment laws are offered for legal protection for consumers referring to how many hours they work or the provision of price -floor in the labour market to see how much they earn against the minimum wage.

Conclusion

To conclude

http://en.wikipedia.org/wiki/Price_signal

http://tutor2u.net/economics/content/topics/marketfail/market_failure.htm

http://tutor2u.net/economics/revision-notes/as-marketfailure-government-intervention-2.html

http://tutor2u.net/economics/revision-notes/a2-micro-market-failure-introduction.html

http://en.wikipedia.org/wiki/Free_price_system

http://en.wikipedia.org/wiki/Externality

http://en.wikipedia.org/wiki/Market_failure

References

Moffatt M. (2010). Definition of Free Market Economy. Available: http://economics.about.com/cs/economicsglossary/g/free_market_e.htm. Last accessed 18th Dec 2010.

(N, A). (2010). Free market. Available: http://www.investopedia.com/terms/f/freemarket.asp. Last accessed 18th Dec 2010.