Free Markets: Supply & Demand

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While many cite the work of Adam Smith and his theories of free markets -- today few acknowledge that Smith identified limitations of his "invisible hand" and directly stated there was a role for government. Are notions of "free markets" realistic? Do they accurately model how consumers and vendors interact?

This depends on whether or not the original assumptions in Adam Smith's theories, which were created hundreds of years ago when markets were dominated by many small sellers, describe the markets being evaluated.

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Free Markets: Supply & Demand

  1. 1. Free Markets – Real or Myth Politicians, Pundits, Business Professionals and Economists talk about “Free Markets” Do they exist in the real world?
  2. 2. Free Markets • Definition (noun): An economic market or system in which prices are based on competition among private businesses and not controlled by a government • Based on writings of Adam Smith, 1776
  3. 3. According to Smith… • • • • Sellers and buyers act in self-interest Sellers maximize profits Buyers maximize utility (usefulness) Neither is interested in the other’s bestinterest • Buyers like lower prices • Sellers like higher prices • How do we “balance” this?
  4. 4. Smith DID Say • Government has a role in “free” markets • With no oversight, there are no “free” markets • Market regulation is necessary • The private sector will not supply all goods and services we may want or need • There are “public” goods
  5. 5. Theory: Demand
  6. 6. Theory: Supply
  7. 7. Theory: Supply & Demand
  8. 8. Theory: Shortage
  9. 9. Theory: Surplus
  10. 10. Smith’s Assumptions • • • • • • Behavior is rational Everyone has equal power/influence Free entry/exit in markets Competition: many buyers & sellers No one influence’s price, “price takers” Perfect information: we know all choices • Many factors influence perceived value of a product
  11. 11. Value of Economics • Economic theory creates models • Like a model train, boat, plane, these models are not perfect • They may not even be accurate • Model may provide useful information • Valid for some purposes • Be careful – model has limitations too
  12. 12. Is Economic Theory Valid? • Supply and demand model does not describe all markets • Too much diversity in the real world • Interactions are complex • Supply & demand are not natural laws like law of gravity & physics • Different cultures may have different attitudes, values, and beliefs
  13. 13. Online Learning • http://www.bized.co.uk • Please click on LEARNING ZONE • Then click on ECONOMICS (left navigation) • Click on MARKETS • Click on DEMAND & SUPPLY

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