Understanding the free market economy requires being clear about what it is and how it works. Otherwise the danger is too great of lapsing into cliches and platitudes.
In another article, I'd suggest you read, I defined the free market economy with a heavy emphasis on principles of voluntary exchange. As important as the principle is, so is appreciating its function. This function is important as it generates as overall increase of social wealth. How it does so entails understanding the dynamics of voluntary exchange.
On the matter of social wealth, though, let me explain. This term should not be misinterpreted as referring to some collective good. It is used here to refer to the aggregate wealth in a society, based upon the total wealth of the individuals who constitute the society. Voluntary exchange increases the wealth of the most people. It is only in this sense that I refer to 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 is exactly wrong. The confusion is due to a failure to understand a couple key economic facts: 1) transaction costs and 2) subjective preferences. Transaction costs are inherent in any exchange. For this discussion, it is important to remember that in any exchange both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
1) It's hard to see why a trader would bother making an exchange if he valued what he was buying equal to what he was selling. But even if he did do such a thing, for whatever whimsical reason, he would pay the price of a total loss in the process. This would be because, while the goods bought and sold were held as equally valuable, he would have to cover the transaction costs of the exchange.
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 you time and energy are transaction costs. Why incur them if you don't care whether you have an apple or the dollar in your pocket? (And, incidentally, the fact that you did incur and accept those transaction costs should be regarded as evidence whatever you say, or even think, you do in fact prefer the apple to the dollar.)
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.
If you're feeling hungry as to approach the local grocer's store, you may well decide you value an apple more than the dollar in our pocket. You may value it so much more that even after incurring the transaction costs mentioned above, you'd still rather have the 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.
Likewise, the grocer's valuing of the goods is subjectively different from yours. He already has a bin full of apples, for which he has already paid. The funds he needs to run his store and support his family depends on actually selling the apples which he bought for just that purpose. The grocer values your dollar more than the apple and is as happy to make the exchange as is the hungry version of you. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit: it increases the likelihood you'll be willing to incur the transaction costs on your end.
How often does it happen, when you get to the cash and pay, both you and the grocer say thank you at the same time? Why not? You're both appreciative of the exchange; you both got something you valued more for something you valued less. You both are wealthier than you were before the exchange.
The total social wealth has increased. And it does so every time such a voluntary transaction occurs. Herein lays the magic of a free market economy. The freer it is, the more total social wealth is generated.
In another article, I'd suggest you read, I defined the free market economy with a heavy emphasis on principles of voluntary exchange. As important as the principle is, so is appreciating its function. This function is important as it generates as overall increase of social wealth. How it does so entails understanding the dynamics of voluntary exchange.
On the matter of social wealth, though, let me explain. This term should not be misinterpreted as referring to some collective good. It is used here to refer to the aggregate wealth in a society, based upon the total wealth of the individuals who constitute the society. Voluntary exchange increases the wealth of the most people. It is only in this sense that I refer to 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 is exactly wrong. The confusion is due to a failure to understand a couple key economic facts: 1) transaction costs and 2) subjective preferences. Transaction costs are inherent in any exchange. For this discussion, it is important to remember that in any exchange both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
1) It's hard to see why a trader would bother making an exchange if he valued what he was buying equal to what he was selling. But even if he did do such a thing, for whatever whimsical reason, he would pay the price of a total loss in the process. This would be because, while the goods bought and sold were held as equally valuable, he would have to cover the transaction costs of the exchange.
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 you time and energy are transaction costs. Why incur them if you don't care whether you have an apple or the dollar in your pocket? (And, incidentally, the fact that you did incur and accept those transaction costs should be regarded as evidence whatever you say, or even think, you do in fact prefer the apple to the dollar.)
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.
If you're feeling hungry as to approach the local grocer's store, you may well decide you value an apple more than the dollar in our pocket. You may value it so much more that even after incurring the transaction costs mentioned above, you'd still rather have the 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.
Likewise, the grocer's valuing of the goods is subjectively different from yours. He already has a bin full of apples, for which he has already paid. The funds he needs to run his store and support his family depends on actually selling the apples which he bought for just that purpose. The grocer values your dollar more than the apple and is as happy to make the exchange as is the hungry version of you. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit: it increases the likelihood you'll be willing to incur the transaction costs on your end.
How often does it happen, when you get to the cash and pay, both you and the grocer say thank you at the same time? Why not? You're both appreciative of the exchange; you both got something you valued more for something you valued less. You both are wealthier than you were before the exchange.
The total social wealth has increased. And it does so every time such a voluntary transaction occurs. Herein lays the magic of a free market economy. The freer it is, the more total social wealth is generated.
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