The Wonder of The Free Market – 3

The Wonder of The Free Market – 3

Question from MBA Candidate  (student) – “But can citizens and the free market really fix themselves? A comment from the website of the Department of Justice (2011) states that the competitive process, which is found within free markets, only works when competitors set prices honestly and independently.”

I guess I’m partial because I work for a state agency, but they do have their benefits. True, when the government steps in, their intervention never seems to be truly successful, but we as humans are imperfect, therefore an imperfect market exists; when there are such practices as price-fixing and bid-rigging, then that tells me there are flaws everywhere.

References:
(2011) Price fixing, bid rigging and market allocation schemes.  Retrieved from http://www.justice.gov/atr/public/guidelines/211578.htm

PJU Response:

Basically, you are pointing out illegal ways that some people try to manipulate price, and just like you, I agree this illegal behavior calls for government action. But it does NOT call for government price intervention, rather 1) either putting people in jail or 2) heavily fining them for violating the rules of the game or 3) otherwise removing them from the marketplace. Just like you, I want and the free market needs, in fact demands, regular and reasonable enforcement of a reasonable rule-of-law that fosters competition.

A different take from the DOJ website might be that free markets only work when government enforcement reasonably and regularly enforces a reasonable rule-of-law such that competitors firms feel free to set honest and independent prices.  A meaningful motto might be: Government price intervention – never! Government refereeing, of course!

However, perhaps you might read this DOJ comment more carefully. First of all, the only way free markets really work is that almost all firms are price-takers, not price-makers or price-setters. This observation does not include monopolies, which are almost all heavily regulated by local, state-wide or regional government regulatory bodies, like corporation commissions. Or cartels like OPEC, which manipulate supply, therefore manipulate price, and which entities are outside of the reach of US law enforcement.

Yes, I agree that someone in the firm sets a price for the firm’s product or service, then the consumers in the marketplace either buy the product or service, on not. But these type of ‘price-setters’ are really only gauging the market and mechanically setting a price at what they think the market will bear.

Take bread, for instance. If your grocery store started charging eight dollars a loaf for bread you could buy bread loaves at a dozen other nearby places for four dollars a loaf, how much of the eight dollar loaves would you buy? None, right? Why?

Because the free market, without government intervention, sets the price, based on supply and demand interaction and either your firm follows, or your firm might reap zero revenues. This is true with almost any product or service, as long as there is a free market. This price mechanism is called the “invisible hand” and is the hallmark of free markets.

Collectively, imperfect human beings DO NOT create imperfect markets very often, if the government wisely referees. Unless they are not truly free markets, of course, which is what happens when the government intervenes!!!

 

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