Characteristics Of A Free Market Economy

1548 Words Nov 17th, 2014 7 Pages
Market failure occurs when a market equilibrium cannot be reached due to an inefficient allocation of resources, therefore meaning that scarce, finite resources are not being used optimally. It arises due to deviations from the assumptions of an idyllic free market, leading to productive and social inefficiency (Hill,2006).
One of the defining characteristics of a free market economy is that resources are allocated through the price mechanism. Referring to Figure 1, we can see that initially, bananas were supplied at Q1 tonnes for P1 - the market equilibrium. If the banana demand increases, the curve will shift from D1 to D2. This raises the price from P1 to P2, and quantity supplied from Q1 to Q2 tonnes. But, the price will not persist as the price increase signals for firms to produce more bananas, shifting the supply curve from S1 to S2. This creates a new market equilibrium as quantity supplied shifts from Q2 to Q3 and price decreases back to P1. In addition, free markets assume Pareto optimality, where individuals cannot become more well off others becoming worse off (Hill, 2006). Also, there would be defined legal ownership of all resources and access to free perfect information.

There are a number of reasons why market failure in agriculture occurs. One of the reasons is imperfect competition such as monopsony where there are a large number of sellers but only a single buyer. Due to the high buying power of supermarkets such as Tesco, farmer profits…
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