What is a Free Market Economy?

A free market economy is a decentralized economic system, where the government does not attempt to impose regulations on market transactions. In a free market economy, the allocation of economic resources, level of production, and prices are determined by supply and demand.

Restrictions on Free Market Economies

Though a free market economy is considered to be the most efficient type of economy, this concept in its purest form is not found anywhere in the world. Instead, countries have significant public sectors that provide some services. Also, governments impose regulations on some aspects of an economy. Further, governments may provide subsidies in certain areas and impose unusually high taxes in others. These factors alter the impact of supply and demand, resulting in less-efficient markets, though perhaps markets in which social needs are being met to a greater extent than would otherwise be the case. For example, government intervention in a free market economy may be warranted in the following situations:

The level of production is too high, based on the resulting impact of production on the environment. By imposing regulations on production, environmental costs are factored into the cost of production, which increases the prices at which goods are sold.
There is a temptation for suppliers to collude in order to artificially raise prices, so the government imposes anti-trust regulations to maintain a higher level of competition.
Developers may construct shoddy buildings, so the government imposes building codes to ensure that minimum standards are met.

The amount of government regulation imposed will typically depend upon the desires of the population, as expressed through their voting choices for political candidates.

Advantages of a Free Market Economy

There are multiple advantages to a free market economy. First, it spurs innovation, since anyone can enter a market and compete. The result is high levels of competition in terms of both product features and price, which is beneficial to consumers. Another advantage is that the high level of competition in this environment results in very high productivity, since competitors must be productive to stay in business. Otherwise, their cost structures will fall behind those of competing firms, and they will eventually incur losses and go out of business.