Why is the concept “free market” important to a study of economics?


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No study of Economics can begin without an understanding of the fundamental concept of afree market. In fact, economics itself is the study of exchange. Any study of exchange that does not take into account the particular conditions under which the study of exchange is being conducted cannot be called economics. The concept “free market” is an important construct that makes such analysis of exchange possible. Before we understand the concept free market, however, it helps to understand the concept exchange first.

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What is exchange?

To most of us, exchange is the process of giving something that we have to get something else that is in the possession of the other party to the exchange. In economics, such exchange is only one of two forms of exchange and is called interpersonal exchange. In any interpersonal exchange, each party to the exchange offers the other a certain quantity of a good (or service) and receives from the other party a certain quantity of another good (or service). The quantity exchanged of each of the goods is something that is usually decided by the two parties through a process of negotiation.

Types of exchange possible

For the purpose of understanding the concept “free markets”, I am identifying two broad categories of exchange.

  1. Voluntary exchange – In this type of exchange, both parties to an exchange enter into the exchange on their own volition. No force of any sort is used to make the exchange happen. A typical example is when you walk into a grocery store and buy 2 kilos of rice. Both parties, you and the owner of the grocery store, enter into the transaction voluntarily. The price is agreed upon by negotiation.
  2. Forced exchange – In this type of exchange, one party uses force to make the other party agree to give up the good when in the absence of the force, the second party would not have agreed to do so. An example of this is robbery at gun-point. The robber uses the gun to force the victim to give up possession of the money and other valuables on his person in exchange for the robber not pulling the trigger and killing or hurting him grievously. In the absence of the threat, the victim might not have given up his money and other valuables. Another example of forced exchange is slavery. The slave is forced to offer his labour to his master, in exchange for which he gets food, clothing, shelter and a basic level of security.

What is a Free Market?

The term free market refers to a hypothetical construct. It is an abstraction. In simple language, the term free market is used to refer to an environment where all exchange is voluntary and dependent only on the choices of the individual(s) engaging in the exchange. In a negative sense, a free market is one in which no individual uses force to bring about an exchange and where no one else other than the individuals engaged in the exchange may set the terms for it. A “free” market may thus be understood as a hypothetical social system free from the use of force by one individual against another.

Why is the concept “free market” important to a study of economics?

Economics is the study of exchange. Starting from the premise that all exchange is voluntary, economics applies deductive reasoning to axiomatic concepts in order to identify the laws that govern the functioning of the free market. In its methodology, Economics is like Mathematics. The laws of Economics have the same validity as the theorems of Mathematics. Like the theorems of Mathematics, the laws of Economics are not and cannot be validated through experimentation. They can be shown to be false only by showing their premises to be faulty or by pointing out errors in the reasoning used to arrive at them.

Having identified the laws that govern the functioning of a free-market, Economics then goes further to study the effect of the introduction of forced exchange into the free market. The tool it uses is, once again, deductive reasoning. The concept “free market” enables us to conceptualise an environment devoid of the use of force by one human against another, thus making economic analysis through deductive reasoning possible. It is only the concept “free market” that enables the identification of Economic laws.

Is a free market desirable?

Going by the definition I have given above, a free market is just an environment where every individual is free to act as per the guidance of his own mind. Banishing force from exchange essentially means that every individual has to and can only participate in the market by producing goods and services that others would want and by offering those goods and services in exchange for the goods and services that others in turn produce. The free market is therefore a system where every individual is engaged in the production of goods and services that are useful to others and enhance their quality of life. Thus, the free market makes possible a wide array of goods and services that make human life longer, healthier and happier. It therefore appears most desirable to anyone who genuinely wishes an improvement in the conditions of his own life and chooses to attain the improvement in a peaceful manner through voluntary cooperation with his fellow human beings.

What are the common charges leveled against free markets?

The free market is frequently blamed for a number of our problems, be it economic recessions or severe shortages in the provision of healthcare and education to the poor or environmental degradation. The main charge against the free market is that it is based on untrammeled greed and is hence a dog-eat-dog world where only the fittest survive while the weaker ones fall by the wayside. It is blamed for rising inequality of income and the growing gap between the rich and the poor. It is also accused of being prone to frequent and catastrophic failure bringing hardship to millions of people.

Economic analysis, however, demonstrates that all these charges against the free market are false. In fact, it demonstrates that all the problems identified above and many others are not a result of free markets but of sustained and systematic interventions in the free markets by an agency capable of intervening in this manner. What that agency is, how it intervenes in the free market, how a free market works and what needs to be done to usher in a genuine free market is something I will cover over the course of many articles to follow.

Is a free market possible at all?

It is probably not possible at all, but it is possible to move ever closer to the ideal of a free market. Once may never be able to say that there will never be individuals who will not use force against other individuals. In all likelihood, there will always be murderers, robbers, fraudsters, kidnappers, pickpockets, rapists, etc. What a free market may do is to provide services to try to reduce the incidence of and to handle situations created by such events. The important point, which economic analysis demonstrates, is that only a free market is capable of providing a sustainable economic environment in which human beings can be engaged in a never ending effort to improve the quality and quantity of their lives.

 

Written by- 
Bala
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Vanguard B-School
Vanguard is founded by IIM & XLRI alumni with the objective of creating industry-ready achievers for Corporate India. The programs at Vanguard are designed keeping in mind the right mix of practical Business Knowledge, Industry Skills, and the Attitude of an achiever. A uniquely designed Mentorship Program with more than 50 industry experts from various industries will provide personalised guidance to each Vanguard student.

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