What is a free market? Plus the benefits and drawbacks

Updated 10 March 2023

The term free market, or open market, refers to an economic system that is usually dynamic and based on supply and demand, rather than one that is mostly controlled by governments. An open market is the opposite of a controlled economy, where a government agency plans the use of resources, production and prices. It's helpful to understand how free markets resources and companies belong to private entities or individuals who can trade contracts freely with each other. In this article, we examine the pros and cons of an open market, its characteristics and the impact they have on businesses.

What is a free market?

A free open market economy is self-regulated and controlled by supply and consumer demand. An entirely open market doesn't have a government agency regulating the different aspects of the economy. By withdrawing any government regulations, the open market then forces individuals, businesses and corporations to ensure that they provide consumers with superior services and products that identify and address the needs of their consumers. An open market helps those who are selling to create prices everyone can afford.

Command vs open market

In both command and planned economies, it's normal to find that there is a relatively high control in how wealth distribution and production occurs. The governments oversee the amount a business or corporation can produce and own. They also decide what wages employees earn and create legislation around the cost of services and goods. In contrast, for free-market economies, rather than central governments, controlling how a corporation or business produces and develops goods, operates daily and runs its services is usually based on consumer demands.

Individual businesses and corporations decide on their level of supply and the amount their employees can earn with commodities also selling at the highest price possible. The definition of a free market economy is also said to be the truest form of capitalism. This is because profit is the driving factor of all supply, demand and production, allowing businesses and corporations to become highly efficient.

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Nuances of an open market

An open market is an economy that allows product and service exchange willingly through a seller and a buyer. An excellent example of this economic exchange is the sale of groceries at a price that is set by the store or the farm grower. Another instance of economic exchange is a business or corporation paying an employee's salary. With an open market economy, there are no barriers when selling goods and services. This allows individuals to sell products of their choice with no limitations on the price they wish to charge buyers.

It's important to remember that the economic system of a completely unrestricted open market is rare. Tariffs and taxes added to exports and imports along with some legal restrictions, such as the minimum age restriction implemented on the sale of alcohol. Many of the capitalist economies that most democracies have established are a mixed system comprising both command economy and open market components.

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Financial implications of an open market

Below are some of the economic dependencies of an open market:

The connection between the open market and capitalism

In today's world, there is no country that operates an entirely unrestricted open market. With that, most of the world's open markets usually coincide with nations that have a high value of individual rights, capitalism and private property. This is true as many political systems shy away from subsidies or regulations for their individual behaviours that have less of an interference with any transactions that are voluntary. An open market is far more likely to thrive and grow when in a system where they protect property rights and there is an incentive for capitalists to pursue profits.

Financial markets and open markets

In an open market, developing a financial market can help to facilitate the financing needs of those who can't self-finance or simply don't want to self-finance. An example of this is businesses or individuals specialising in the acquisition of savings by being consistent in not over-consuming their present wealth. While there are others whose main pursuit is entrepreneurial activity, which they gain through expanding or starting businesses by deploying their savings. Many of these individuals benefit from financial security trading, such as bonds and stocks.

For example, many savers purchase bonds from their current savings from entrepreneurs with the promise of savings in the future plus interest or remuneration. With stocks, individuals trade their current savings for an ownership claim on any potential future earnings. As mentioned before, an entirely open market rarely exists in the modern world. There are no examples of such an open market.

Characteristics of an open market

An open market is an economic system the closest to true capitalism, as it's usually driven by consumer demand and supply and by private ownership. Complete economic freedom is a fundamental feature of this type of economic system. It's the main reason it's so difficult to find many examples of an entirely true open market. A free-market economy is easily distinguishable from other types of economic systems by other characteristics, such as:

The freedom to participate

The reality that any individual can partake in an open market economy is one of the key characteristics. It's a completely voluntary decision by each individual to consume or produce a particular product. This results in individuals, businesses and corporations having the choice to purchases as little or as much product as they wish.

Privately owned resources

An open market economy exists because there is a significant part of the nation's resources that many businesses, corporations and individuals within the private sector own. Unlike other types of economic systems, these resources aren't owned by a central government-run agency. This allows for the owners of the resources to have complete control over the way allocation, exchange and the production of products occurs while also having control over the supply of labour.

Financial markets that are thriving

Another fundamental characteristic of a successful open market economy is the financial institutions' presence throughout the market. Brokerages and banks exist so to give businesses and individuals a way in which they can exchange services and goods and provide businesses and individuals with investment services. This results in financial institutions being able to make a profit through fees applied to transactions or by charging interest.

The pros of an open market economy

The lack of influence from the government allows for corporations, businesses and individuals to have a large amount of freedom. Here are some pros regarding an open market economy:

Customer demand drives choices

An open market allows consumers to decide what products are successful, and which products fail. When a consumer has two product options, they evaluate the features of each product and decide to choose the one they feel is best suited to them. Normally consumers choose the one that has what they require while also offering the best value for their money.

Consumers also have a great impact and influence on the price of a product. It's important that producers hit the balance between a price point that results in them still earning a profit while still being affordable to their customers.

Freedom to innovate products

An open market economy system allows business owners to enjoy coming up with new product and service ideas based on the needs and wants of their consumers, without restriction. Businesses have the freedom to offer new services and develop new products at a time that suits them. There is no influence on the creation timeline. Entrepreneurs avoid government agencies that inform about current consumer needs and wants. Many entrepreneurs carry out research themselves while being able to identify popular consumers trends that may be arising.

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The cons of an open market economy

Even though there are many benefits of an open market economy, there are still a few drawbacks to one. Here are some to consider:

Failed markets

It's possible that occasionally an open market may spiral out of control, which can lead to devastating outcomes. The crash of the real estate market in 2008 and the Great Depression in 1903 are both excellent examples of an open market failure. Market crashes like this have dire consequences, such as lost income, unemployment and homelessness.

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Profit motive dangers

Some producers may be solely driven by profit motives. This is one of the major disadvantages of an open market. The number one goal for most corporations and businesses is to earn a profit, but the needs of employees and consumers are the major priority, and generating profit comes after. A business can't put the safety of its employees at risk or have disrespect for the working condition and environmental standards.

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