Free Market

Question 1

What is the Economic System?

Answer 1

Economic system is a network of individuals, organisations and
institutions used by a society to resolve the basic problem of what, how much, how and for whom to produce.

Question 2

What are the characteristics of a Free Market Economy?

Answer 2

Also known as a laissez-faire, market or capitalist economy:

• Private ownership of resources

• Owners of resources and producers are free to buy/sell

• Economic agents are motivated by self-interest

• Consumers have sovereignty – they determine what is produced
by being willing and able to buy goods and services

• Income depends on the market value of an individual’s work

• Resources are allocated by the price mechanism (market
mechanism)

Free market economies still require the allocation of property rights
and a legal system to protect them.

Question 3

Advantages of a Free Market Economy?

Answer 3

• Resources can be bought and sold

• Consumer sovereignty

• Freedom of choice

• Profit-motive and self-interest incentivises

• Incentive to worker harder for higher wages; productivity rises

• Firms face competitive forces driving down prices

• Incentive to innovate and invest in new ideas (dynamic efficiency)

Question 4

Disadvantages of a Free Market Economy?

Answer 4

• Income/wealth inequality, and poverty

• Market failure can reduce social welfare

• Lack of provision of public goods

• Over-provision of goods with negative externalities

• Under-provision of goods with positive externalities

• Information gaps may cause market failure

• Unemployment/worker exploitation/low pay for some

• Environmental depletion/degradation

• Resources may be wasted on advertising and marketing

• Firms may develop monopoly power and push up prices

• Macroeconomic instability