Economic Systems

How Free Is Our Economy?

No country has a fully free market economy. Most countries have a mix of free market and command economy elements—with the mix for some being mostly free and for others, mostly command. The United States has a mixed market economy, mostly free market, with some elements of a command economy. Our mixed market economy gives businesses and consumers a lot of freedom to do what they want. But the government still has an important role to play.

What does a mixed market economy mean to the average person living in that economy? If you are a consumer or a business owner, you make up the market (buyers and sellers). In a mixed market economy like ours, you have a lot of freedom to decide what you buy or what you sell, based on your own self-interest. Consumers meet their needs and wants through consumption. Businesses pursue profit through production. However, the government may insert itself into the market if leaders believe they need to.

The incentive to make a profit inspires businesspeople to use their self-interest to fill the needs and wants of consumer households. The desire for profit drives innovation and ensures a variety of goods and services get to the marketplace according to consumer demand and at prices consumers are willing to pay.

Acting in Self-Interest

In a free market economy, consumers make purchase decisions based on their self-interest, and business owners operate to benefit their own self-interest. It’s a balancing act: Customers decide what they need and want, where they’ll buy it, and how much they’ll pay for it. Businesses choose what they offer for sale and how much they want for it.

By watching out for their own self-interests, each helps the other. How is this possible? Because self-interest isn’t the same as selfishness. Self-interest involves making decisions that are beneficial for you and others. Businesses want to make a profit, and to do so, they must serve their customers. Consumers need products and services, as well as income from the jobs businesses provide. The two turn out to serve each other as well as themselves.

Free Market Economy

A free market economy leaves production, consumption, and pricing decisions largely to consumers and to businesses, also known as producers.

In a free market economy, businesses decide whether to make soap or cars, bread or electronic games. Farmers decide what to grow on their land: corn or lettuce, soybeans or strawberries. They create the supply available for sale and base their decisions on consumer demand. Factories, farms, and businesses are private property in a free market economy. These entities own most productive resources, and, within limits, they’re mostly free to determine:

• What to produce with those resources.

• How to produce.

• How and where to offer the product for sale.

• What prices to charge.

U.S. businesses have most the freedoms afforded by a free market economy, but the government has its say.

Producing for Profit

Production’s sole purpose is consumption. Producers produce so consumers can consume. What does that mean? Imagine a food truck. Its owner bought it to make a living. She buys food and every day makes sandwiches. Why? So people will consume them. She wouldn’t do it unless she thought enough people would pay a price for the sandwiches high enough for her to make a profit.

How do businesses decide what products and services to offer? They think about their customers. It’s in companies’ self-interest to give people what they need and want at prices people are willing to pay. That way, companies earn revenue (money coming in) that covers their costs (expenses required to provide the product) and ideally makes them a profit. Profit means businesses earn more than they spent to produce and distribute what they sell. Profit is the reward for taking on the risk, effort, and responsibilities of running a business.

The Circular Flow of the Economy

Prices strike a balance between what consumers will pay and what businesses need to make a profit. If businesses aren’t profitable, they could close down, or they could switch to producing something else. Under normal circumstances, prices are set by an unspoken negotiation between buyers and sellers. Sellers set a price and then lower it if they don’t attract enough buyers to make a profit. Or they raise it if they have more buyers than products. When the number of consumers demanding a product suddenly increases, or the supply suddenly decreases, shortages can result.

If this happens, a mixed market economy may shed some free market features and temporarily invoke features of a command economy: that is, a small group of government officials may make decisions about what is produced and how it is priced. For example, in the United States, during the COVID-19 pandemic, government officials invoked the Defense Production Act to require companies to make specific products, such as ventilators. In circumstances such as this, the government becomes the consumer. Even so, both parties still negotiate over pricing, because both still have self-interest to consider.

Consumer Choices Affect Profits

Businesses understand that consumers have choices. Consumers will pass on buying from a particular business if they are not satisfied with the quality or the price of whatever is being sold. Profit can turn into loss any time the costs of doing business rise above revenue. Losses cause the businesses to rethink their products, their prices, and what the customer values. If a business uses what it learns to make changes, it can turn a loss into a profit, and consumers will get what they need and want at acceptable prices.

The Role of Government

In a completely free market economy, the government plays a minimal role, with few major functions. It protects the private rights of citizens with respect to life, liberty, the pursuit of happiness, and property. It also provides a few goods of great social benefit that cannot be provided profitably by businesses. Examples of these goods in the United States include national defense and interstate highways.

Currently, no countries have a truly free market economic system with only limited government involvement. The U.S. government exerts strong influence in market decisions and serves as a check on self-interest. It prevents monopolies, addresses price gouging in emergencies, and provides economic incentives, such as stimulus funds or bailouts, when needed.

But should the government always step in? When shortages lead to price gouging, government intervention can have a negative effect on prices and availability in the long term. Instead of letting high prices adjust consumer behaviors, government intervention might involve removing items from shelves; in that case, no one can have those items, even those consumers who would have agreed to the high price. When the government interferes in the market, it generally means well, but it may cause more problems than it fixes. This news clip shows intended and unintended consequences of government intervention to prevent price gouging.

Shortages in a Crisis

Grocery checkers have been trained to ask, "Did you find everything you need?" And typically, you do. But during an emergency, such as a hurricane or pandemic, shortages affect us all. The value of grocery staples, as well as hand sanitizer, masks, and even toilet paper, may soar as specific consumer needs and wants outstrip supply.

A limited government in a fully free market economy interferes very little beyond a few specific functions. The U.S. economy has evolved from a mostly free market by adding a growing layer of bureaucracy. As a result, the government has a very strong influence, for better and worse.

Most countries cannot sustain free market systems because people have a low tolerance for suffering. Estonia and Hong Kong both have some of the freest economies. But free markets have flaws, and these flaws can lead to catastrophic consequences. Some economists believe that the "invisible hand of the market" will correct imbalances, but in the meantime those who are affected by that particular market failure suffer. People don't want to suffer and don’t want others to suffer, so they give the government more control to help prevent poverty and suffering.