Sunday, April 19, 2009

Free Markets (11) - Benefits

Free markets are good, because well-functioning markets allow people to exchange things they do not want for things that they need. This enables them to improve their situation in life.

In a world without markets every person has to produce everything that they need. If there is no way of exchanging goods and services, everyone has to be self sufficient (unless a generous person gives them something or they steal from someone else). Making everything that you need is very difficult, so a self-sufficient rarely moves above subsistence level. People spend so much time producing food and shelter, they did not have time to develop and make other products that they may want.

A free market changes everything, because it allows people to specialise and trade. One person specialises in growing grain. Another specialised in catching fish. A third person specialises in baking bread. Each one does what he is most skilled in doing. By focusing on one task, each person can increase their skills and find ways to do a task more efficiently.

The person who specialises can produce more than they need to survive. They can trade their surplus production with others to get all the things they want. Trading in a free market improves the situation of almost everyone, because specialisation makes everyone more productive.

I do not have a clue about how to make a computer or a flat screen TV. I could not make a decent automobile, if I worked on if for a hundred years. If I made my own clothes, I would look like a caveman. However, by specialising in tasks that I am skilled at doing, I can afford to buy all these things and many more.

Not a Zero Sum Game
What takes place in a market is not a zero sum game. In a zero sum and action that makes one person better off makes someone else worse off. Consider a family that has only one doll. If they take it off one child and give it to another, the situation of one child improved, but the other is worse off. In a zero sum situation, benefitting one person always harms another.

The functioning of a free market is totally different. A market is not a zero sum game, because every transaction that takes place in a market makes both parties to the transaction better off. If Bob sells his car to John for $5,000, the transaction improves the situation of both. This is hard to believe, but it happens because different people place different valuations on the same good or service (the technical name for this is subjective value). The transaction described above benefits John, because the car was of more use to him than the $5,000. Bob also benefits because he places a greater value on $5,000 than he does on the car.

The experience of Bob and John is not a rare example. They same thing is repeated in every transaction that takes place in a free market. A transaction cannot occur unless both parties benefit. If Bob thought his car was worth more than John was willing to pay, he would not sell it. If John felt that Bob was wanting too much for the car, he would refuse to buy it. This is the situation with every transaction in a free market. Both parties to the transaction have a right of veto. If either the buyer or the seller thinks, they are will not benefit from the transaction, they can simply walk away.

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