What is the Market
The concept of market used by economists is not the same as the popular notion of market used in normal conversation. A market for economists is not a place, nor an institution. The market is a process. The process of people that have things exchanging the ownership over these things with other people that wants them.
From the above paragraph, it is evident that the very existence of a market presuposes the concept of ownership. Only when there is private property is possible to talk about a proper market.
We call transaction to every individual exchange of the ownership over a pair of things. You give me bread, I give you money in exchange. Or I give you another thing in exchange. Money is not necessary for a market to exist. It is just convenient.
When using money as the medium of exchange it is customary to call the party of the transaction that gives the ownership or use rights over the thing the "seller", and the party that pays using money the "buyer".
This distinction between buyers and sellers is important because, contrary to popular belief, usually the buyer has a little advantage over the seller in any particular transaction. The buyer has money, which is accepted by everyone, and can usually compare and choose what kind of good he wishes to buy with his money and whom to buy from, or completely abstain from making a purchase. On the other hand the seller has only a limited set of goods to sell and these goods are not necessarily wanted by everybody. As we shall see on this blog, overcoming this intrinsic disadvantage by some sellers that have problems attracting buyers is the cause of most market distortions.
In an economy, the combination of the different markets for all the goods produced in the econmy is called the Market, with a capital M. Since there are a myriad of different goods and many possible interactions between them, the Market is extremely complex and for all practical purposes impossible to organize, much less optimize, from above.
What about the free market
Most economists would agree in principle with the description of the Market provided above, even if it is very simplistic. In contrast any proposed definition of the free market is likely to provoke a heated discussion, resulting in many competing (and uncompatible) definitions of free market. Many of these definitions are carefully designed to suggest the impossibility of the existence of a Free Market in the real world, by imposing conditions that are not possible.
One of these impossible conditions that is frequently used is to demand perfect knowledge on the part of sellers or buyers. It is said that a market cannot be free unless all parties involved have perfect knowledge in order to prevent that those that have better knowledge take advantage over those less knowledgeable.
Since perfect knowledge is never attainable in practice, free markets are impossible, thus the government should organize markets. Quod erat demonstrandum.
Another popular demand is perfect competition. It is alleged that a market cannot be free unless there are enough competing firms offering a particular good. This is a very misleading concept. What level of competition is enough? How do we establish what goods (or companies) compete with a given one? Usually there are no objective answers. Goods (or companies) that compete with each other under some circumstances might cease to compete under different circumstances (or vice versa).
As we shall soon see, the important issue is not the number of competitors that are present in the Market, but whether some potential competitors are prevented to enter the Market (or existing competitors are for ced to exit it) by force.
Impossing conditions that are impossible to attain in a real-world free market, or that are too vague to be useful, only create confusion. They only prove that a perfectly free market is impossible, but we already knew that. Nothing made by humans is perfect.
In other words, there are markets precisely because there are differences between what people have and what people want and there is no perfect knowledge to solve these differences in an optimal way. The free market is the best way to distribute limited resources in an equitable way in a world that is not perfect.
Almost all the economic problems that exist in a particular time and place can be reduced, not by regulating the Market more tightly, but rather by making it freer. But before trying to demonstrate why that is so, it is necessary to have first a working definition of the Free Market.
So, what makes a market free
The answer is surprinsingly simple. There are only two simple conditions that result in a free market:
- That transactions are voluntary, and
- That there is free entry to the market (both for sellers and buyers)
That's all that is required!
Voluntary transactions eliminate most of the problems that are frequently used to justify a government intervention.
- If transactions are voluntary, it is guaranteed that both parties are better off after finalizing any transaction. Otherwise it would not have taken place.
- Conversely, transactions that take place only because there is some coercion involved imply that at least one of the parties (usually both), is worse after the transaction. Otherwise, the coercion would not be required.
I accept that it is theoretically possible to obtain a better general outcome using non-voluntary transactions, if those that benefit from the imposition gain more than those that are harmed. But even if that were the case (and I have serious doubts that in the real world these theoretical cases exist), it is difficult to justify on moral grounds why some people has to be penalized for the greater good. It is even more difficult (maybe it is impossible) to establish mechanisms to prevent abuses.
But having voluntary transactions is only a necessary condition that is not sufficient.
If a seller cannot enter the market, buyers are not really free to voluntarily choose the best possible deal for them and will have to settle for a deal that is probably more advantageus to the existing sellers.
Altough it is generally less of a problem nowadays, it was widespread in the past to impose barriers to buyers. If certain buyers are not allowed to buy certain good, the remaining buyers have an unfair advantage, while the sellers of the good are harmed.
While the condition of voluntary transactions is relatively easy to understand and to apply, the liberty of entry to the market is conceptually much more difficult to understand and even more to implement.
It is usually straight forward to see if a transaction is voluntary or not. If the parties participate in the transaction without any external coercion, the transaction is voluntary. Otherwise it is not. Besides, voluntary transactions are almost always right.
In the case of the liberty of entry to the market, the situation is more difficult to assess because some barriers to entry are acceptable (even desirable), while others are not. And sometimes is very difficult to assess whether certain barriers are acceptable or not.
Obviously to become a seller it is at least required that you own the good that you are intending to sell. If producing the good is expensive, or requires a particuler skill, or takes some time or a prior investment, then you might not be able to enter the market but there is nobody to blame. It is just the nature of the world.
Similarly, to become a buyer of a good, you are at least required to know that the good exists and have the means to acquire it. Not being able to afford a particular good someone wants might be deplorable for that person, but it is not a market failure. It is just the consequence of the fact that economic goods, by definition, are scarce.
Unfortunately, it is certainly possible to create conditions that limit entry to the market that are neither necessary nor reasonable. These conditions have to be prevented to ensure that a market is free.
The purpose of this post is just to define the conditions required for the Free Market to emerge. Even if the formulation of these conditions is much simpler than what is usually used to caracterize the Free Market, there are still some nuances that have to be carefully considered to prevent abuses. These will be the subject of future posts.