How a Free Market Works

Today most of the modern developed economies125$ - 2200 items
are built on the free market principles first110$ - 3600 items
introduced by the famous economist Adam Smith.At the same time manufacturers are ready to
We all have many times heard about theproduce and sell at following prices and quantities:
supply-demand model which is always represented100$ - 850 items
by the intersecting curves on the graph. I’ll120$ - 1200 items
try to illustrate the main concept of the free140$ - 1500 items
market in a bit simpler way not using those150$ - 2000 items
graphs.Looking at above two tables we may notice
First let’s understand 2 basic assumptions ofwhen the volume of production equal to 1500
the free market economy: the Law of Demanditems both customers and suppliers agree with
and the Law of Supply.the price. Such coincidence normally determines
The Law of Demand states that as the price of athe price and the quantity of the product to be
good increases consumer demand for that goodsold and bought at the market. Consequently
will decrease and vice versa. Simply speaking if140$ could be named the market price for mobile
we used to buy a bottle of beer for 3 USD andphone in our example.
one day we observe at some store the sameFor such market following rules are valid:
bottle for 5 USD we would hardly buy it. On theIncrease in demand leads to the increase of the
other hand if the same beer would be offered tomarket price and vice versa.
us just for 2 USD we would readily buy a dozenIncrease of supply leads to the decrease of
of.market price and vice versa.
The Law of Supply states that as the price of aTo understand why it works this way, we get
good increases, the quantity of goods offered byback to above case with mobile phones. We have
suppliers increases and vice versa. Here we shoulddetermined that the optimal volume to be
think from the supplier or producer standpoint. Ifproduced at that virtual market would be 1500
your company manufactures a fashionableitems with the price equal to 140$ per item.
clothes, you would be interested to have a shopLet’s imagine that at this market demand for
in Milano, where people used to pay well for it,mobile phones suddenly rose. That will end up with
rather than in Mexico where lots of low incomethe situation when all mobile phones are sold out
population can’t afford an expensive wear. Inbut certain customers still remain unsatisfied.
other words seller always keen to produce andKnowing the desire of seller to sell at a higher
sell more at a higher price to maximize profits.prices (Law of Supply) those customers will start
Bear in mind that both of above laws are validto offer more than 140$ for the phone to secure
only if all other factors remain equal. For instancethe deal. Thus average market price will go up.
when comparing Milano and Mexico in aboveLet’s now take reverse case when demand
example we have apparently ignored the hugeto phones has fallen or supply has risen what
difference in the size of population of those tworesulted in surplus of phones at the market. In
cities.this case suppliers knowing the desire of
Once these 2 laws are understood we maycustomer to buy cheaper (Law of Demand) will
switch to the main point of the free marketdecrease the price to sell unrealized phones. Thus
economy – how the price and quantity ofaverage market price will go down.
goods determined. Let’s take mobile phonesLaws of demand and supply can be depicted on
for example. Bearing in mind the Law of demandthe graph as a curve lines, visually showing how
let’s suppose how many phones customersthese rules work. Intersection of lines will be the
of our market are ready to buy at each particularmarket price. Moving lines inward or outward will
price:demonstrate the increase or decrease of market
150$ - 1000 itemsprice.
140$ - 1500 items