Free market economy is an economy of an efficient market, in which the vast majority of the largest part of economic activity is organized by private individuals, entrepreneurs, for personal gain. (Kates, 2011). These private individuals are not in the service of the government. They make their own decisions about what to produce, whom to hire, what kind of equipment to use, and what price to set. Every participant of the market has all the information needed as it becomes available and reflects in prices. (Ang, Goetzmann, Schaefer, 2011).
No market is absolutely laissez-faire. However, in a market economy, despite the government’s participation in the economic process, it is the private entrepreneurs who make the fundamental decisions about what and how to produce and at what price to sell.
The closest by its characteristics to the free market is the stock market. Consider the change in demand for U.S. government bonds in 2002.
As the result of collapse of the U.S. stock market in 2000, by the first half of October 2002 the fall of the U.S. stock market indices was: Dow Jones Industrial – 37.5%, S & P-500 - about 50%, NASDAQ Composite – 78% comparing to the absolute maximum in the beginning of 2000.
A simple calculation showed that the index was still falling by 2.5 times. Financial companies and funds become restructure their investment portfolios. The transfer of funds fleeing from the stock market investors to the relatively risk-free assets became noticeable. Demand for the government bonds increased. As it shown on the Graph 1, the demand curve for the government bonds shifted to the right. At the current price and profitability of the securities, this caused the situation when the government bonds demand exceeded supply (shortage). To make the new equilibrium, the market had to adjust the price of the securities to a higher level. According to the demand low, the demand growth leads to the price increase.
In relation to government securities, price growth on them can be expressed also in reducing their profitability. Growth in demand for these securities led to a sharp drop in their profitability: in early 2000, the yield on 10-year U.S. Treasury bonds exceeded 6.75% in mid-2003 it had fallen to 3.14%, and a two-year government securities yield dropped almost to 1%.
- Ang, A., Goetzmann, W.N., Schaefer, S.M. (2011). The efficient market theory and evidence: implications for active investment management. Hanover. Publishers Inc.
- Kates, S. (2011). Free market economics: an introduction for the general reader. Cheltenham. Edward Elgar Publishing Limited.