The economy is intimately linked to politics. Governments set economic policies that affect global markets, employment, wages, working conditions, and other factors affecting economic livelihoods. In turn, economics affects politics, sometimes in mysterious ways. In the United States, although there is a free market system, there are examples of free markets and controlled practices.
In 1776, Scottish economist Adam Smith formulated ideas on the free market economy in his seminal book, The wealth of nations. The book describes the principles underlying what has become the doctrine of let it go economy – a French term which literally means “to let it be” or “to let it be”. The idea is that if the markets for goods and services are left unaffected or unregulated, they will naturally develop an effective equilibrium or equilibrium. The invisible forces which guide the economy towards equilibrium have been expressed by Smith as an “invisible hand”.
To better understand the idea of the laissez-faire economy, it helps to look at a basic graph of supply and demand.
In this chart, the vertical Y axis represents price and the horizontal X axis represents quantity. The supply curve represents the incentives of the producers and has a positive slope. When prices are low, there is an incentive for suppliers to produce only a few goods. When prices are high, suppliers prefer to produce and sell more goods. The demand curve is opposite. It has a negative slope and represents consumer incentives. When the price of products is very high, consumers demand a low quantity. When the price of goods is very low, consumers demand more. The point of intersection between the supply and demand curves represents an equilibrium point.
This is a transcript of the video series Understanding the US government. Watch it now, on Wondrium.
Industrial revolution and the free market system
Smith’s ideas were compelling and ushered in a new era of liberal economic thought. But in the 1800s, the industrial revolution was in full swing. And with the great advancements in technology and machinery, the world’s producers have dramatically increased their capacity to manufacture goods and in many cases reduced their costs. As might be expected, the evolution of technology has had real-world implications for the free market’s ability to balance.
In 1867, the influential German philosopher and economist Karl Marx wrote about the fact that the free market system did not sufficiently take into account the role of workers and that laissez-faire capitalism would lead to their exploitation.
In the late 19th and early 20th centuries, there were examples of abusive labor practices, 50- or 60-hour work weeks, low wages, unsafe conditions, and even child laborers. According to Marx, the solution to such problems was that the workers own the means of production, so that there would be a stronger bond between the producers, managers and entrepreneurs, on the one hand, and the workers who carried out work to create goods, products and services, on the other hand.
Learn more about the first innovators of the American textile industry.
Economic Philosophies of Adam Smith and Karl Marx
To some extent, the economic philosophies of Adam Smith and Karl Marx can be viewed as the end points of a continuum.
At one end is a purely liberal capitalist system, without regulation or formal organization. At the other end of the spectrum is a purely socialist system where the collective rights of workers are privileged over an individual’s ability to produce and trade goods.
In fact, no country in the world has an economic system that is a pure version of either of these examples.
Adam Smith’s ideas about the free market are so well supported by the mathematics behind them, that one wonders why markets don’t work perfectly all the time. It turns out, however, that under certain conditions the invisible hand does not do its magic and the balance is not found. This is called a market failure.
Why is a market failure occurring?
First, the drive to create public goods imposes particular challenges on societies and markets. When people are looking to create something that cannot be controlled, it is difficult to get people to contribute to it. In other words, public goods create the conditions for free riding, which leads to problems of collective action.
Second, some industries have significant barriers to entry. Often times, high start-up costs are a common obstacle for a producer trying to enter a market. For example, in a perfect market, a number of airlines at different prices and levels of service would be created to meet market demand. However, an airline is a very expensive business to start up, so barriers to entering the airline market mean that there are often insufficient suppliers relative to the demand for the service.
The third source of market failure are sectors that lack sufficient competition among suppliers. We often talk about monopoly. Monopolies are formed when one or a small handful of producers dominate a particular economic sector. In many industries where monopolies exist, the problem is that a single producer can raise prices above an equilibrium price.
Learn more about American capitalism.
Other sources of market failure
Fourth, some industries naturally have negative externalities which are a direct consequence of the production of their goods. For example, coal and steel are huge industries with huge markets. However, the process of their production is extremely taxing on workers and on the environment. These negative consequences are known as negative externalities and can be viewed as a type of market failure.
The last form of market failure comes from information asymmetry. In some industries, producers and consumers have access to different levels of product information. When consumers don’t really know how a product was made, what ingredients are in it, or the price at which other producers are selling a product, then producers have more market information than consumers. When this happens, it is impossible for the invisible hand to produce the point of balance.
Common questions about the American economic system
The idea behind the doctrine of let it go economy is that if the markets for goods and services are left unaffected or unregulated, they will naturally develop an effective equilibrium or equilibrium.
Adam Smith purely favored free market capitalist system, without regulation or formal organization. On the other hand, Karl Marx supported a purely socialist system where the collective rights of workers were privileged over an individual’s ability to produce and exchange goods.
When sectors lack sufficient competition between suppliers, we often talk about monopoly. Monopolies are formed when one or a small handful of producers dominate a particular economic sector.