16.2 The Case for Free Markets

Within a secure framework of law and order, and well-defined and
enforced property rights, a modern economy can function at least
moderately well without further government intervention in markets. In
this section we review the case for free markets. In subsequent sections
we study government functions that arise when free markets fail to
produce acceptable results.

Free markets are impressive institutions. Consumers’ preferences and
producers’ costs lead to demand and supply decisions that generate price
signals. These signals coordinate separate decisions taken by millions of
independent agents, all pursuing their own self-interest. In doing so, they
allocate the nation’s resources without conscious central direction.
Markets also determine the distribution of income by establishing prices
of factors of production, which provide incomes for their owners.
Furthermore, modern market economies, where firms compete to get
ahead of each other by producing better goods more cheaply, generate
the technological changes that have raised average living standards fairly
steadily over the past two centuries.

In presenting the case for free markets, economists have used two quite
different approaches. The first of these may be characterized as the
“formal defence” and is based on the concept of allocative efficiency,
discussed in Chapters 5  and 12 . The essence of the formal defence of