Chapter 2.2 The Free Market

Chapter 2.2: The Free Market
Markets exist so that people can exchange
what they have for what they want. A free
market is a self-regulating economic system
directed by individuals acting in their own selfinterest.
Markets and Why They Exist
• Market: an arrangement that allows buyers
and sellers to exchange things (examples:
farmer’s market, stores, the NY Stock
Exchange, a babysitting flier)
• They exist because no one is selfsufficient; none of us produces all we
require to satisfy our needs and wants
• They allow us to exchange the things we
have for the things we want
• Each of us produces just one or a few products;
specialization is the concentration of the
productive efforts of individuals and firms on a
limited number of activities. This leads to
efficient use of resources.
• This leads to buying and selling; we need
markets to sell what we have and buy what we
want. If everyone was self-sufficient there would
be no need for a market of any kind.
Free Market Economy
• Economic systems that are based on voluntary
exchanges in markets
• Individuals and businesses use markets to
exchange money and products
• The main players in the free market economy
are households (people who live in the same
residence) and firms (organizations that use
resources to produce a product which it then
• Firms transform “inputs”/factors of production
into “outputs”/products
• Factor Market: the arena of exchange
where firms purchase factors of production
from households to try to make a profit
(financial gain made in a transaction)
• Product Market: the market in which
households purchase the goods and
services firms produce
Adam Smith
• Scottish social philosopher who published
The Wealth of Nations in 1776 where he
described how the market functions
• He said that the buyer and seller only
consider their own self-interest, or
personal gain, which is the motivating
force behind a free market
• Incentive: the hope of reward or the fear of
punishment that encourages a person to
behave in a certain way
• Adam Smith observed that people and
consumers respond predictably to both
positive and negative incentives
• Competition: the struggle among
producers for the dollars of consumers
“The Invisible Hand”
• Term economists use to describe the selfregulating nature of the market place
• Our market place mostly runs itself without
any central plan or direction; self-interest
causes us to buy certain things and firms
continue to produce them, while
competition causes more production while
preventing firms from increasing prices
Advantages of the Free Market
• The free market meets the following economic
goals we learned about in 2.1:
– Economic Efficiency: the free market is self regulating
and responds efficiently to changes
– Economic Freedom: free markets have the highest
degree of freedom of any system, from workers to
firms to individuals
– Economic Growth: Competition encourages
innovation, which encourages growth
– Additional Goals: Offers a wider variety of goods and
services than any other system. Consumers having
the power to decide what gets produced is consumer

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