CHARACTERISTICS OF FREE MARKETS
These are the typical characteristics one would expect of truly free markets. They are nothing new and there have been rivers of ink written about them. We are going to review them quickly and then move forward.
Economic decisions
A free market is composed by people voluntarily exchanging goods and services. This exchange is done with the implicit and explicit purpose of gaining an advantage. Each party wants to get more than it is offering. This value assessment is purely subjective. It changes from person to person, from second to second. There is no magic calculator, algorithm or rule that would enable us to measure the “true value” of an item. All these assessments are purely subjective.
As they are so, the “value” of something to be exchanged can only be compared to the value of some other thing by the very same person. For example, I am thirsty and therefore at this moment I value more a bottle of water than the 5 Reales it costs. Tomorrow, while at home, I can get water for free from the tap, therefore I will value those 5 Reales more than a bottle of water.
We also have the issue that just “thinking” about value does not determine its value. Thinking is free and in economic terms, nothing is free. Until the very moment that I exchange those 5 Reales for a bottle of water, it is all theoretical (i.e. meaningless). This is so because a market is not a place where people exchange ideas, but a place where people exchange goods and services. Until this exchange happens, values are just ideas.
Once the exchange was done, the only information we can extract is that for myself, on that day and that time, a bottle of water was more valuable than 5 Reales. That’s it. Anything else is conjecture.
This subjectivity is crucial and it is also the very reason why markets are so difficult to understand. Calculations cannot be used in order to understand them.
Supply and demand
Supply is the pressure created by all the people trying to sell goods and services. Demand is the reluctance created by all the people to exchange their money for those goods and services being offered.
If there would be no reluctance, there would be no markets since suppliers would only need to show their goods and services in order for them to be automatically bought.
A transaction only happens when the reluctance of the demand is overtaken by the supply offer. This reluctance can happen for different reasons and in different ways:
- Supplier lowers the price (discount)
- Supplier points out benefits (sales pitch)
- Buyer wants the product more than the money it costs
It is this supply and demand that ultimately determines the cost of a good and service. If the supply is low, there will be many buyers and the price will tend to rise. If the Demand is low, there will be many suppliers and the price will tend to drop.
This rise and drop occur mostly because of time requirements and preferences of market participants. Usually, buyers prefer to receive goods and services immediately and suppliers prefer to deliver goods and services immediately.
This is so, because when buyers want something, they value those items more than the money they are willing to spend, but this willingness is only temporary. Sellers have ongoing costs and therefore they cannot afford to wait. They also know that buyers may change their minds at any moment. So, they prefer to make a sale and delivery now.
When supplies rise, buyers know that every supplier will be able to deliver immediately. Therefore, they value their money more than delivery speed, which is the same for all suppliers. The price drops. When supplies drop, buyers know many suppliers won’t be able to deliver immediately. Therefore, they value speed more than their money. The price rises.
Of course, this is not the only mechanism at work, but it is a big one.
Market equilibrium
There is this theoretical notion that free markets must be perfect or close to perfect, in order to deliver its benefits. Rivers of ink have been spilled, forests have been harvested for paper and countless prizes (including Nobels) have been issued to economists studying market approximations and so-called “failures”.
All of this is, of course, pig manure. The position of these academics is upside down. The gist of it being that because free markets do not conform to their theoretical models, they are somehow imperfect… and therefore they must be managed.
Note to reader: you will notice that this “management” concept will show time and time again in many of our lessons. This is so because politicians want job security and they will accept any pseudo-scientific notion for as long as it allows them to justify their jobs.
They state that in more or less “good” conditions, and when “competition” is acceptable, and when the mechanisms of supply and demand more-or-less work and when the market is not influenced by external issues, then, the market distributes goods and services more-or-less according to buyers wishes but limited by purchasing power which makes prices tend towards an “equilibrium” which in turn tends to a “Pareto optimum” which is the definition of market efficiency. Got that?
It is like declaring that gravity should have a value of 10 m/sec2 instead of the measured 9.8. You see, 9.8 is not a nice round number easily divisible by other round numbers. Therefore, there must be something wrong with gravity and we need to find out what it is. Yes, it is that ridiculous!
You may remember from our definition why we study free markets. Because they work and they are optimized. They are optimized in the real world, not in some theoretical mathematical quagmire. Although markets definitively evolve, each evolutionary step is optimized. Markets are self-optimizing systems.
What economists call “problems” or “market failure” are nothing more than the price to be paid to have an optimized system in the real world. Of course, economists don’t see it that way. They can’t restrain themselves from tweaking free markets to “adjust” them to theoretical optimizations. The tiny problem with this thinking is that any “tweaking” interferes with the optimization and then something else, usually something much bigger and ugly, takes place. What all these economists forget is that there is no free lunch. They change something small here and something big there goes out of synch or stops working altogether.
The market is in equilibrium with itself. It is the best equilibrium that can be achieved in the real world, simply because equilibrium spawns from balanced forces that appear in the real world: supply and demand. It is not a perfect equilibrium and it is not a static equilibrium. It changes all the time. Ask a stock trader if you don’t believe us. But that’s ok because it fulfills the golden rule: it works better than anything else.
What they are trying to do is to put a straightjacket on a chita (you know, the big running cat) and then complain that it is not hunting as it used to do! Ludicrous!
Note: please see the Glossary if you are unfamiliar with certain words.
Continue to Introducing Mr Free Market - Part 3
