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    Can anyone describe the cases for and against the free market? I find it confusing.

    Market Failure.

    The free market only accounts for the parties DIRECTLY involved in trade.

    The supply curve is defined by the PRIVATE marginal cost to the firm.
    • Raw Materials
    • Land
    • Labour
    • Capital

    The demand curve is defined by the PRIVATE marginal benefit to the consumer.
    • Income
    • Cross price elasticty
    • Utility

    These two curves intersect at the point at which the benefits to the individual and the costs to the supplier are in equilibrium. The price and quantity are derived from this intersection.

    However sometimes there are things called NEGATIVE EXTERNALITIES

    These are things that impose costs onto others not involved in trade. A THIRD PARTY. An example of this is climate change. People buring fossil fuels raise the sea level which makes some people in Bangladesh homeless :mad:. This costs them the value of their property.

    For the SOCIALLY OPTIMAL LEVEL of output to occur ALL of the marginal costs should be accounted for which the free market does not account for.


    Thus the supply curve should be shifted inwards to account for the negative externalities to achieve the social marginal cost. The size of the shift in the y axis is the size of the negative externality.

    Governments can attempt to account for these negative externalities by taxing goods proportionally to their negative externality. However this does not always have the intended consequences as it is difficult to quantify the external cost. IE how do you quantify the cost of airplanes going over peoples homes?

    I have covered negative externalities here however the same is true for positive externailities just the other way around. However in this case the demand curve shifts out as the positive externailities are a SOCIAL BENEFIT.

    The other problem with the free market is information failure. Consumers are unaware of the true BENEFITS of a good. An example of this is education. It would be underconsumed if it was not free. Hence the government intervenes and subsidies it or promotes it using advertising.

    Sorry a bit rambly but the AS stuff is in there.

    Take a look at An Introduction to Economics that you can download for free from www.keweipress.com Chapter 1 deals with the free market and its working and Chapter 2 covers what goes wrong with it and why it is by no means perfect.

    And good luck!

    Try tutor2u, its helped me a lot, hope it helps.

    Good luck!
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