Practical Economics:    

The Wonder of the Free Market

Previous Student A:

If people in leadership positions of both corporate America and our government are unable to make hard choices and correct real problems, what kind of future will we as individuals have in the years to come?  

For instance, how can I move towards advancement in my field and retirement in the future without the constant fear of potential economic and social failure weighing on my mind? What kind of investments exist that might escape those in real power positions from demolishing and destroying them in my lifetime?  

Your REAL Worry 

You have stated both an economic worry and a political concern. Simply put, elections matter plenty. If we elect politicians that move us towards what Geoff Colvin calls "moderate, low-tax, market-friendly economic policies", (see Fortune Magazine 3/19/2012, p 90) then we will increase our political freedom and our future is bright.

Your worry, in my humble opinion, is exactly why the free market comes to the rescue. The free market thrives because needs are being met, and there is a free exchange of money for goods or services that rewards the supplier for knowing what goods and services to provide and that rewards buyers by them getting exactly the goods and services they want and need. If such a free market also includes real property rights and true privacy, then we have both political freedom and economic freedom, which combination allows a robust free market in most things.

Perhaps we Americans ought to care more about politics and freedom than we sometimes do. Without political freedom, our future is seriously constrained. Assuming a solid degree of political freedom, may I explain a bit more how a free market (economic freedom) works to solve problems?

Music Industry Example  

Let's look at the music industry in America. For years, even decades, the music industry tried hard to act like an economic cartel (think OPEC) dictating price and quantity and even what the medium might be. But with the advent of digitization, the five firms in charge grew further and further apart from their customers.

In fact, by the 1990s these music firms were suing their customers in court! Why? How did this level of disconnect between producers and consumers happen? It happened because music consumers were downloading music to a non-sanctioned medium, without paying for that music.

In days gone by, this quasi-monopoly had performed an important function to music creators and music performers by providing a distribution channel to consumers, which justified (somewhat) their financial cut of music revenues. But with digitization, the distribution channel changed and the previous barrier between music creators and music consumers disappeared.

Apple Wormed Themselves into a Rescue  

Yet the government did not and could not solve this problem. Instead, the free market, in the form of Apple, rode to the rescue. Apple created the iTunes store and a music player called the iPod which together made it possible and easy to download music from the Internet to the iPod for $.99 a tune. Customers loved this option and the music industry was saved, mostly - with a heavy dose of Apple, of course.

Now, music creators get their cut for being creative and music owners own relatively inexpensive music and carry the music around with them everywhere. How many billions of 99-cent tunes have been downloaded from the iTunes store?

Long story short, we want and need as much freedom and liberty and property rights and thriving free markets as possible. Government intervention only mucks up the process, at best, and kills most of the options available, at worst. We want both political freedom and economic freedom.

Previous Student B - But can citizens and the free market really fix themselves? A comment from the website of the Department of Justice (2011) states that the competitive process, which is within free markets, only works when competitors set prices honestly and independently. 

True, when the government steps in, their intervention never seems to be truly successful, but we as humans are imperfect, therefore an imperfect market exists; when there are practices such as price-fixing and bid-rigging it tells me there are flaws everywhere. References: (2011) Price-fixing, bid-rigging and market allocation schemes. Retrieved from http://www.justice.gov/atr/public/guidelines/211578.htm

Is There a Role for Government Setting Prices?  

Basically, you are pointing out illegal ways some firms manipulate price, and like you, I agree, this illegal behavior calls for government action to enforce a reasonable rule-of-law, when those laws are being broken. But price-fixing and bid-rigging does NOT call for government price intervention, but rather either putting people in jail or heavily fining them for violating the rules of the free market or perhaps removing them from the marketplace. The free market needs, in fact, demands, regular and reasonable enforcement of a reasonable rule-of-law that fosters competition.

A different take on the DOJ website might be that free markets only work when government reasonably and regularly enforces a reasonable rule-of-law such that competitor firms feel free to set honest and independent prices. A meaningful motto might be: Government price intervention - never! Government refereeing, of course!   

In fact, perhaps you might read this DOJ comment more carefully.  

First of all, the only way free markets really work is that almost all firms are price-takers, not price-makers or price-setters. (This observation does not include monopolies, which are almost all heavily regulated by local, state-wide or regional government regulatory bodies, like corporation commissions. Nor does it include cartels like OPEC, which manipulate supply, therefore manipulate price, which entities are outside of the reach of US law enforcement.)

Yes, I agree that someone in the firm sets a price for the firm's product or service, which price then allows the consumers in the marketplace either to buy their product or service, or not. But this type of 'price-setter' is really only gauging the market and mechanically setting a price at what they think the market will bear, based on the interaction of supply and demand, aka the 'invisible hand' identified by Adam Smith. 

Look at the Example of Bread 

Take bread, for instance. If your neighborhood grocery store started charging five dollars a loaf for bread you could buy (a nearly identical substitute) at a dozen other nearby establishments for three dollars a loaf, how many of these five-dollar loaves of bread would you buy? None, right? Why? Because the free market, without government intervention, sets the price, based on supply and demand interaction and either your firm follows, or your firm reaps zero revenues and end up with truckloads of unsold bread.

This is true with almost any product or service, as long as there is a free market. This price mechanism (invisible hand) is the hallmark of free markets. A more technical term for this interaction of thousands or even millions of individual buyers and sellers voting with their money is the equilibrating process. 

Collectively, imperfect human beings DO NOT create imperfect markets very often, if the government wisely referees. Unless they are not truly free markets, of course, which is what happens when the government intervenes!!!

Conclusion  

If you want to maximize the number of choices available to you, long-term, then vote for candidates who strive to maximize the amount of political freedom and economic freedom you enjoy.