Understanding the free market economy requires being clear about what it is and how it works. Otherwise the danger is too great of lapsing into cliches and platitudes.
Elsewhere, I've defined the free market economy in a way that put the emphasis upon principles of voluntary exchange. The function of this quality is another matter. It has to do with the overall increase of social wealth. Understanding how a free market economy increases social wealth requires understanding the dynamics of voluntary exchange.
On the matter of social wealth, though, let me explain. This term should not be misinterpreted as referring to some collective good. It is used here to refer to the aggregate wealth in a society, based upon the total wealth of the individuals who constitute the society. Voluntary exchange increases the wealth of the most people. It is only in this sense that I refer to social wealth.
How then does voluntary exchange achieve this growth of social wealth? Many people have difficulty understanding this because they labor under the illusion that any goods exchanged, to be exchanged, must be of equal value. The assumption is that neither economic actor to a trade would exchange if what they were selling might be valued higher than what they were buying. Thus trades of non-equivalent value either can't happen or only happen when someone has suffered a loss. And, in that case of course, the total social wealth would be unchanged.
This assumption is precisely mistaken. The analytical failure lies in confusion over a pair of essential economic facts: 1) transaction costs and 2) subjective preferences. Trades entail costs that are intrinsic to the transaction. Remember that in all trades both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
If one of the traders valued what he was buying equal to what he was selling that would be a straight up exchange, with no value gained. However, because of the transaction costs of the exchange, he would be losing.
Think of buying an apple from your local grocer. Let's say you valued the dollar in your hand and the apple in the store exactly equally. You literally wouldn't care which you had. But if you really didn't care, would you take a detour from your journey to enter the store, walk to the apple bin, examine them to find one ripe and without bruises, then walk over to the cashier and wait in line to pay?
Those are all transaction costs to your time and energy. Why would you incur them if you really didn't care whether you had an apple or the dollar in your pocket? (If you did incur those costs that would be empirical evidence that contrary to what you said, or thought, you obviously did prefer the apple to the dollar.)
2) Here is the second point usually ignored in assuming exchanges of equal value: subjective preferences. If you're having difficulty getting your head around how two people exchange goods, with both being able to buy a good more valued that what they sold - that is, both can become more wealthy from the same exchange - it is this matter of subjective preference that you're missing. People have different values at any given moment in time.
You might in fact feel hungry approaching the local grocery store and as a consequence value an apple more than that dollar in your pocket. This greater valuation of the apple could be so much greater than the value you attach to the dollar that you are happy to pay the inevitable transaction costs (entering the store, choosing an apple, waiting in line).
That does not thereby make the apple objectively more valuable. This is just a manifestation of your current subjective valuing of the apple. Yesterday, while passing the grocer's, following a big lunch, not being at all hungry, subjective valuing of dollar and apple likely would have been quite different.
Also, of course, the grocer has a big bin of apples, which have already been purchased. To earn the profit necessary to make the store a going concern, the grocer wants to sell the apples. Thus, the grocer values your dollar more than the apple you receive in return. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit.
How often does it happen, when you get to the cash and pay, both you and the grocer say thank you at the same time? Why not? You're both appreciative of the exchange; you both got something you valued more for something you valued less. You both are wealthier than you were before the exchange.
Thereby, the total social wealth has been increased. This is the magic of a free market economy. And the freer it is, the more total social wealth can be created.
Elsewhere, I've defined the free market economy in a way that put the emphasis upon principles of voluntary exchange. The function of this quality is another matter. It has to do with the overall increase of social wealth. Understanding how a free market economy increases social wealth requires understanding the dynamics of voluntary exchange.
On the matter of social wealth, though, let me explain. This term should not be misinterpreted as referring to some collective good. It is used here to refer to the aggregate wealth in a society, based upon the total wealth of the individuals who constitute the society. Voluntary exchange increases the wealth of the most people. It is only in this sense that I refer to social wealth.
How then does voluntary exchange achieve this growth of social wealth? Many people have difficulty understanding this because they labor under the illusion that any goods exchanged, to be exchanged, must be of equal value. The assumption is that neither economic actor to a trade would exchange if what they were selling might be valued higher than what they were buying. Thus trades of non-equivalent value either can't happen or only happen when someone has suffered a loss. And, in that case of course, the total social wealth would be unchanged.
This assumption is precisely mistaken. The analytical failure lies in confusion over a pair of essential economic facts: 1) transaction costs and 2) subjective preferences. Trades entail costs that are intrinsic to the transaction. Remember that in all trades both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
If one of the traders valued what he was buying equal to what he was selling that would be a straight up exchange, with no value gained. However, because of the transaction costs of the exchange, he would be losing.
Think of buying an apple from your local grocer. Let's say you valued the dollar in your hand and the apple in the store exactly equally. You literally wouldn't care which you had. But if you really didn't care, would you take a detour from your journey to enter the store, walk to the apple bin, examine them to find one ripe and without bruises, then walk over to the cashier and wait in line to pay?
Those are all transaction costs to your time and energy. Why would you incur them if you really didn't care whether you had an apple or the dollar in your pocket? (If you did incur those costs that would be empirical evidence that contrary to what you said, or thought, you obviously did prefer the apple to the dollar.)
2) Here is the second point usually ignored in assuming exchanges of equal value: subjective preferences. If you're having difficulty getting your head around how two people exchange goods, with both being able to buy a good more valued that what they sold - that is, both can become more wealthy from the same exchange - it is this matter of subjective preference that you're missing. People have different values at any given moment in time.
You might in fact feel hungry approaching the local grocery store and as a consequence value an apple more than that dollar in your pocket. This greater valuation of the apple could be so much greater than the value you attach to the dollar that you are happy to pay the inevitable transaction costs (entering the store, choosing an apple, waiting in line).
That does not thereby make the apple objectively more valuable. This is just a manifestation of your current subjective valuing of the apple. Yesterday, while passing the grocer's, following a big lunch, not being at all hungry, subjective valuing of dollar and apple likely would have been quite different.
Also, of course, the grocer has a big bin of apples, which have already been purchased. To earn the profit necessary to make the store a going concern, the grocer wants to sell the apples. Thus, the grocer values your dollar more than the apple you receive in return. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit.
How often does it happen, when you get to the cash and pay, both you and the grocer say thank you at the same time? Why not? You're both appreciative of the exchange; you both got something you valued more for something you valued less. You both are wealthier than you were before the exchange.
Thereby, the total social wealth has been increased. This is the magic of a free market economy. And the freer it is, the more total social wealth can be created.
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