Question: Examine the costs of a free market economy.
A free market economy is an economic system which resolves the basic economic problem through the price mechanism. Basically market demand and supply determine prices and then whoever can afford goods at the market prices can buy them. A rise in the demand for a good means its price increases and firms switch more resources into producing that good. The government’s role is limited to providing the legal framework (property rights) and providing public goods (police).
In a command economy the government directs resource allocation. Central planning is used, that is, the government decides where every input and output is allocated. Jobs are allocated by the government and goods like food and housing are rationed. Basically the government decides what, how and who to produce for.
A major cost of a free market system is market failure. For example, there may be a monopoly, public goods may not be provided and there may be externalities that need internalising. All of these cause a welfare loss because society becomes worse off. On the other hand, a free market may benefit consumer sovereignty. Consumer sovereignty exists because firms will produce the goods that consumers want. Consumers face low prices, high quality and a wide range of choices.
Another possible cost of the free market is inequality. Income distribution may be very uneven, so the rich can afford a lot but the poor cannot buy much. Also, because the government’s role is limited there is little unemployment benefits and spending on healthcare and education so the poor may suffer even further. But, the free market could also encourage productive efficiency. Because there are many sellers, firms must compete and keep costs low and be productively efficient.
Lastly, a free market may create the problem of consumerism. A free market may cause too much advertising and encourage consumers to buy unnecessary goods. But, the free market could equally bring about a lot of innovation. Firms must produce high quality goods to compete with rivals otherwise they will lose consumers. Moreover, firms may need to innovate to produce new goods, attract new consumers and gain an advantage over rivals.