If you want to understand the free market economy you need to be clear about what it is and how it works. Failing that, the tendency is to too easily lapse into well worn 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.
To be clear, social wealth is used here not to reference some illusion of a collective good. Instead, it refers to the aggregated wealth of society. This is the total wealth of the individuals, all added together. Voluntary exchange increases the wealth of all participants. This is the only valid use of the term social wealth.
How, then, does voluntary exchange provide this benefit to social wealth? Many people assume that there is no change in wealth brought about by an exchange. The assumption is that the items exchanged must be equally valuable or the traders would not have traded. (Or, at least, one would have to have benefited at the other's expense - so it all washes out.)
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 .
1) Though it's a bit perplexing why someone would take the bother of trading an item for another that he valued equally, but even if for whatever whimsical reason he did, the final result would be a loss on the part of the trader. This is due to the transaction costs that are entailed in all trades.
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?
All these expenditures of your time and energy are the transaction costs you incur when deciding to buy an apple. Why would you spend your time and energy in this way if you were truly indifferent to whether you had the dollar or the apple?
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.
Feeling hungry as you near the local grocery store could well have you value an apple more than a dollar in your pocket. Your greater valuation of the apple may be so much greater than the dollar that you'd happily incur the transaction costs (detour, perusal, waiting in line) to exchange dollar for apple.
It would be entirely erroneous to conclude though that this makes the apple objectively more valuable than the dollar. All we have here is the value of this one moment on this one day. Yesterday, passing the grocer's store you may not have been hungry at all - perhaps coming from a large lunch with a friend. In that case, your subjective valuing of dollar and apple would have been quite different, equally as legitimate and obviously no less thoroughly subjective as it was today.
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.
A useful lesson arises from thinking about how often at your local grocers that funny moment occurs when, at the conclusion of the exchange, you both say thank you. Is someone confused here? Not at all! You both say thank you because you are both thankful. Each of you received a good that you value more in exchange for one that you value less. They call that a win-win. You are both wealthier thanks to trading goods.
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.
To be clear, social wealth is used here not to reference some illusion of a collective good. Instead, it refers to the aggregated wealth of society. This is the total wealth of the individuals, all added together. Voluntary exchange increases the wealth of all participants. This is the only valid use of the term social wealth.
How, then, does voluntary exchange provide this benefit to social wealth? Many people assume that there is no change in wealth brought about by an exchange. The assumption is that the items exchanged must be equally valuable or the traders would not have traded. (Or, at least, one would have to have benefited at the other's expense - so it all washes out.)
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 .
1) Though it's a bit perplexing why someone would take the bother of trading an item for another that he valued equally, but even if for whatever whimsical reason he did, the final result would be a loss on the part of the trader. This is due to the transaction costs that are entailed in all trades.
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?
All these expenditures of your time and energy are the transaction costs you incur when deciding to buy an apple. Why would you spend your time and energy in this way if you were truly indifferent to whether you had the dollar or the apple?
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.
Feeling hungry as you near the local grocery store could well have you value an apple more than a dollar in your pocket. Your greater valuation of the apple may be so much greater than the dollar that you'd happily incur the transaction costs (detour, perusal, waiting in line) to exchange dollar for apple.
It would be entirely erroneous to conclude though that this makes the apple objectively more valuable than the dollar. All we have here is the value of this one moment on this one day. Yesterday, passing the grocer's store you may not have been hungry at all - perhaps coming from a large lunch with a friend. In that case, your subjective valuing of dollar and apple would have been quite different, equally as legitimate and obviously no less thoroughly subjective as it was today.
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.
A useful lesson arises from thinking about how often at your local grocers that funny moment occurs when, at the conclusion of the exchange, you both say thank you. Is someone confused here? Not at all! You both say thank you because you are both thankful. Each of you received a good that you value more in exchange for one that you value less. They call that a win-win. You are both wealthier thanks to trading goods.
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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