Economics with Free-Enterprise System

Free-enterprise is specified as the freedom of people or groups of individuals to engage in company endeavors with the minimum intervention of the state (or its political apparatus, the federal government) (Smith 1776/1904). There are three parts in this definition. First, free-enterprise is specified as flexibility of people; in classical economic theory, freedom to participate in financial activities is an extension of individual flexibility. Included to that, this freedom to take part in financial activities is corollary to making individual options, which unlimited, constitute individual liberty (like other liberties).

The second part of this definition is the statement that people can take part in service ventures. This can be attained so long as the person has the capital to establish his company. In economic theory, capital is defined as the possessions, in the type of money, innovation, physical infrastructure, human skills, etc. that can have a possible rate of returns. Individuals can utilize this capital to collect wealth, that is, to create more capital and earnings.

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However, in a free-enterprise, capital nevertheless is determined by the laws of supply and demand.

Capital will only have a rewarding rate of return if it is used to producing products demanded by the customers. Capital utilized for producing products not demanded by the public will either have a lower rate of returns or push business into leaving from the marketplace. Lastly, the requisite for free-enterprise is what economic experts call "minimum intervention of the state." In simple terms, in order for the laws of supply and demand to take impact, the government needs to not intervene in the economic activities of the nation.

The laws of supply and demand cannot work in a system wherein economic activities are either restricted or controlled by the state or government. Whenever the government restricts business activities, the natural mechanism of adjusting production and demand becomes blurred (policies), and thus may create an artificial shortage in the market. Added to that, Adam Smith (1776/1904) argued that if markets are left on its own, it will naturally supply the public its demand. The capitalists or businessmen, eyeing public demand as an opportunity for acquiring profit, utilize their capital for producing products that the public demands.

The self-interests of both the businessmen and the consumers will naturally lead to prosperity. Smith (1776) noted however that the government’s roles in the free-market system are limited to the following: 1) military protection of the state, 2) creation of an amiable economic climate, and 3) construction of public works. However, in real life, it is impossible for government not to intervene in the market. Environmental disasters may create a shortage in the market, raising prices to multiple folds.

The government then can institute some price mechanisms in order to protect the consuming public from unregulated and irresponsible business activities. Good and Bad Kinds of Markets in a Free-Enterprise System Because free-enterprise is defined as the freedom of individuals or group of individuals to engage in economic activities with the minimum intervention of the government or state, it is noteworthy that a loose classification of such had been made by different economists. These economists either favor a virtually unrestricted form of free-enterprise or a combination of command and free-market system.

The first set of economists argued that free-enterprise system necessitates the establishment of an economy under perfect competition. These classical economists argued that if government will let the market do its natural function, relative adjustment in prices for certain products will cause a relative change in demand, and also a corresponding change in supply. In the supply side, because every firm in a perfectly competitive market has an equal share of market, a change in the price of one firm will cause a change in the price of other firms.

In the end, the consuming public will benefit from this relationship because prices are well adjusted by market mechanisms. On the wage side, whenever a change in the production inputs occurs, a corresponding change in the wage side also occurs. Firms will adjust their wage schedules and a level of equilibrium is achieved which would benefit the general public. On the production side, classical economists argued that in a perfectly competitive market changes in prices of goods will have a corresponding change in the wage level; the price level described as flexible and the wage rate inflexible.

Whenever a change in prices of goods occurs, all will follow, and thus the market will be in a state of equilibrium. In this condition, the supply and demand for goods are situated in one price (for a particular good). When equilibrium is reached in the market, both the aggregate demand and aggregate supply in the market becomes relatively equal. This will prevent the creation of an artificial shortage in the market. These conditions of free-enterprise however work in an ideal situation.

In reality, the government can intervene in the market in at least three ways: 1) control the activities of monopolies and cartels, 2) set price controls for certain basic goods, and 3) control the supply of money. These functions may be classified as effective or necessary. It can be necessary because these activities and conditions will naturally affect the general welfare of the public. Effective because government interventions may take the form of a general welfare policy far removed from the rumblings of the political arena.

Monopolies and cartels are perverted forms of the free-enterprise system. Monopolies usually control the larger portion of the market supply of a particular good. The implication is that these monopolies can dictate the price in the market at the expense of the general public. It is expected that the deadweight loss in this condition will be much larger than economies with imperfect market competition (economies differentiating products), precisely because the welfare surplus is converted into a certain rate of profit by the monopolies.

They can do this by controlling the supply of goods in the market. Since they control most of the supply of a particular good, prices will be adjusted based on the profit schedule of the firm. Cartels function the same way as monopolies but differ in two ways. Monopolies usually involve one firm who controls most of the supply of a particular good in the market. Cartels are composed of firms producing the same product and have relatively equal share of the market pie of a particular good.

These firms may corrode to control the price of a good in the market to achieve the expected level of profit, and of course to avoid competition. Welfare surplus in this case will still be large due to the corresponding fall of expected returns to the consumers. What I have outlined are the good and bad kinds of markets in a free-enterprise system. The perfectly competitive market is the ideal free-enterprise system. For theoretical purposes, the perfectly competitive market is itself the free-enterprise system since it well transcribes the characteristics of a laissez-faire system.

However, because this is only an ideal type, perverted forms are well imbibed in the free-market system, that is, they are assumed to be part and parcel of this economic system. In a sense, the definition of free-enterprise that I presented is the definition that captures the postulates of classical economics. Classical economics classified good and bad forms of the so-called free-enterprise system, although it is wrong to argue that there is such thing as “bad free-enterprise” because theoretically it is an ideal type that strives for the good of the general public.

This approach to the definition of a free-enterprise system is classical in nature and does not take into account some of the contemporary economic arrangements that are shaping the economies of many nations, poor and rich nations alike. Capitalism, Neo-Classical Economics, and Free-Enterprise In his book, Carson (2001) argued that the so-called free-enterprise system that classical economists are boasting is in fact transformed into the so-called capitalist system. The capitalist system provides the businessmen when the capacity of limiting the wages of the laborer.

The state now, protects corporations (which are embodiments of the capitalist ordeals) through limited liability, laws on protection of assets, high interest rates, and of course low taxes. It seems that the free-enterprise system which was meant to be at the service of the general public is now an apparatus of the capitalists to expand their share of the market. Capitalism is not free-enterprise. Free-enterprise system is the contradiction of the capitalist system in its economic goals and assumptions.

Keynes (1936) noted that in the era of modern economics, prices of goods in the market are inflexible in the short-run. Short-run adjustments of production schedules and wages will not be smooth since the overall inventory of the firm depends on the expected rate of demand of the public, the actual expenditure, and the price itself. The implication of this is the fact that free-enterprise can only be achieved partially in the long-run. In the short run, distortions in the market will create monopolies and cartels,; in the long-run these will be eliminated, thus the achievement of the so-called “free-enterprise” system.