What is free market economy?

The free market economy is a form of economy in which the market is regulated solely by the price mechanism ( supply and demand ) and not by state intervention. The individual market participants are given the right to develop unrestrictedly.

In this lesson, we describe the most important features of a free market economy, explain the behavior of market participants and address the strengths and weaknesses of this form of economy. At the end you have the opportunity to check your knowledge with a few practice questions.

English: Free Market

Why should you know the free market economy?

According to foodanddrinkjournal, the free market economy is particularly common in Western-style countries and therefore has a particularly high priority among the existing types of market.

The individual countries always use adapted forms of the free market economy, which differ from the theoretical model of this type of economy to different degrees.

It is all the more important to know its elementary characteristics, because the social market economy practiced in Germany can also be seen as a variant of the pure market economy.

Price Mechanism and Free Market Economy

In a free market economy, the focus is on the interplay between supply and demand. At least in the theoretical model, all regulations affecting the markets are made via the price mechanism – without intervention by the state.

Free market economy – supply and demand

Which products are produced or offered at which price is therefore determined solely by the markets. The free market economy is consequently a purely theoretical model, since in all known examples state interventions and regulations are possible, desired or simply necessary.

In the case of a “completely free market economy”, the state should not intervene in any way, not even in the case of arms and drug trafficking. In addition, there should be neither taxes nor customs duties.

The role of the state in the free market economy

Even in a free market economy, the state does not completely withdraw from the action. Rather, he continues to perform important tasks.

According to Adam Smith, the founder of classical economics, the state is responsible for maintaining external security and protecting citizens from unfair treatment and oppression by fellow citizens.

It should also be borne in mind that due to a lack of interested investors, not all tasks can be covered by the private sector. In this case, the state must provide public facilities. In addition, it is its task to counteract the formation of monopolies as far as possible.

free market economy

Example: Free market economy in the USA

The USA, currently the largest economic power in the world, is likely to be the most prominent example of a free market economy. The US economy is characterized by a huge domestic market, which leads to corresponding domestic demand and a high potential of labor.

The two American fundamental values, individual freedom and equality, can be seen as the reason for the pronounced economic liberalism. But here, too, the economy cannot do without state regulations.

The economic and financial crisis of 2008/09 showed that government intervention is necessary here too and may be desired by market participants. The US economy was supported by aid packages and stimulus measures and far-reaching regulations for the financial sector were enacted.

The orientation towards the concept of the free market economy is evident from the comparatively low state quota, which means that the state has a rather small share of the gross domestic product. In the course of the crisis, this rate rose from 36.7% (2007) to 44.2% (2009). By 2012 it had fallen back to 40.7%.

Features of a free market economy at a glance

The following premises fully apply to a free market economy that fully corresponds to the theoretical model. In a market economy that is adapted to the needs of a country, there are corresponding deviations or restrictions.

  • There is complete freedom of contract and free pricing.
  • Production factors are exclusively in private hands.
  • No intervention by the state.
  • Unrestricted freedom of choice in terms of job, consumption, saving and investing.
  • Income is generated solely from the profits of private companies and services.
  • Companies have the freedom to set up shop anywhere, at any time and regardless of the industry.

 

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