Understanding the free market economy requires being clear about what it is and how it works. Otherwise the danger is too great of lapsing into cliches and platitudes.
In another article, I'd suggest you read, I defined the free market economy with a heavy emphasis on principles of voluntary exchange. As important as the principle is, so is appreciating its function. This function is important as it generates as overall increase of social wealth. How it does so entails understanding the dynamics of voluntary exchange.
To be clear, social wealth is used here not to reference some illusion of a collective good. Instead, it refers to the aggregated wealth of society. This is the total wealth of the individuals, all added together. Voluntary exchange increases the wealth of all participants. This is the only valid use of the term social wealth.
So, we begin by asking how voluntary exchange achieves this increase of social wealth. It is often erroneously assumed that an exchange of goods cannot change the aggregate of social wealth. The items exchanged, to be exchanged, must be of equal value. Otherwise the market actors would not have made the trade. The only other option is presumed to be that one must have gotten the better of the other in the trade. In that case, though, the total social wealth would be unchanged.
This is exactly wrong. The confusion is due to a failure to understand a couple key economic facts: 1) transaction costs and 2) subjective preferences. Transaction costs are inherent in any exchange. For this discussion, it is important to remember that in any exchange both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
If one of the traders valued what he was buying equal to what he was selling that would be a straight up exchange, with no value gained. However, because of the transaction costs of the exchange, he would be losing.
Imagine you're strolling along the sidewalk, approaching your local grocer's shop. Now, let's say you value the dollar in your pocket and the apple you might buy for it in the grocery store equally. If that were true, it would be of no consequence to you which of the two you had in your possession. If that was truly how you felt, would you take the detour from your stroll to enter the store, make your way to the apple bin, examine them, looking for one both ripe and free of bruises, then walk over to the cashier and wait for the line to inch along until your turn to pay?
Those are all transaction costs to your time and energy. Why would you incur them if you really didn't care whether you had an apple or the dollar in your pocket? (If you did incur those costs that would be empirical evidence that contrary to what you said, or thought, you obviously did prefer the apple to the dollar.)
2) Here is the second point usually ignored in assuming exchanges of equal value: subjective preferences. If you're having difficulty getting your head around how two people exchange goods, with both being able to buy a good more valued that what they sold - that is, both can become more wealthy from the same exchange - it is this matter of subjective preference that you're missing. People have different values at any given moment in time.
You might in fact feel hungry approaching the local grocery store and as a consequence value an apple more than that dollar in your pocket. This greater valuation of the apple could be so much greater than the value you attach to the dollar that you are happy to pay the inevitable transaction costs (entering the store, choosing an apple, waiting in line).
That does not thereby make the apple objectively more valuable. This is just a manifestation of your current subjective valuing of the apple. Yesterday, while passing the grocer's, following a big lunch, not being at all hungry, subjective valuing of dollar and apple likely would have been quite different.
Also, of course, the grocer has a big bin of apples, which have already been purchased. To earn the profit necessary to make the store a going concern, the grocer wants to sell the apples. Thus, the grocer values your dollar more than the apple you receive in return. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit.
How often does it happen, when you get to the cash and pay, both you and the grocer say thank you at the same time? Why not? You're both appreciative of the exchange; you both got something you valued more for something you valued less. You both are wealthier than you were before the exchange.
The result is that indeed total, aggregate social wealth has increased. Furthermore, this is not some anomaly but the guaranteed outcome of voluntary transactions. The secret of the free market economy is this win-win situation of voluntary exchange. And, the freer the market economy is, the greater the total social wealth that is generated.
In another article, I'd suggest you read, I defined the free market economy with a heavy emphasis on principles of voluntary exchange. As important as the principle is, so is appreciating its function. This function is important as it generates as overall increase of social wealth. How it does so entails understanding the dynamics of voluntary exchange.
To be clear, social wealth is used here not to reference some illusion of a collective good. Instead, it refers to the aggregated wealth of society. This is the total wealth of the individuals, all added together. Voluntary exchange increases the wealth of all participants. This is the only valid use of the term social wealth.
So, we begin by asking how voluntary exchange achieves this increase of social wealth. It is often erroneously assumed that an exchange of goods cannot change the aggregate of social wealth. The items exchanged, to be exchanged, must be of equal value. Otherwise the market actors would not have made the trade. The only other option is presumed to be that one must have gotten the better of the other in the trade. In that case, though, the total social wealth would be unchanged.
This is exactly wrong. The confusion is due to a failure to understand a couple key economic facts: 1) transaction costs and 2) subjective preferences. Transaction costs are inherent in any exchange. For this discussion, it is important to remember that in any exchange both actors simultaneously buy and sell. Money, after all, is just another commodity being exchanged .
If one of the traders valued what he was buying equal to what he was selling that would be a straight up exchange, with no value gained. However, because of the transaction costs of the exchange, he would be losing.
Imagine you're strolling along the sidewalk, approaching your local grocer's shop. Now, let's say you value the dollar in your pocket and the apple you might buy for it in the grocery store equally. If that were true, it would be of no consequence to you which of the two you had in your possession. If that was truly how you felt, would you take the detour from your stroll to enter the store, make your way to the apple bin, examine them, looking for one both ripe and free of bruises, then walk over to the cashier and wait for the line to inch along until your turn to pay?
Those are all transaction costs to your time and energy. Why would you incur them if you really didn't care whether you had an apple or the dollar in your pocket? (If you did incur those costs that would be empirical evidence that contrary to what you said, or thought, you obviously did prefer the apple to the dollar.)
2) Here is the second point usually ignored in assuming exchanges of equal value: subjective preferences. If you're having difficulty getting your head around how two people exchange goods, with both being able to buy a good more valued that what they sold - that is, both can become more wealthy from the same exchange - it is this matter of subjective preference that you're missing. People have different values at any given moment in time.
You might in fact feel hungry approaching the local grocery store and as a consequence value an apple more than that dollar in your pocket. This greater valuation of the apple could be so much greater than the value you attach to the dollar that you are happy to pay the inevitable transaction costs (entering the store, choosing an apple, waiting in line).
That does not thereby make the apple objectively more valuable. This is just a manifestation of your current subjective valuing of the apple. Yesterday, while passing the grocer's, following a big lunch, not being at all hungry, subjective valuing of dollar and apple likely would have been quite different.
Also, of course, the grocer has a big bin of apples, which have already been purchased. To earn the profit necessary to make the store a going concern, the grocer wants to sell the apples. Thus, the grocer values your dollar more than the apple you receive in return. That's why the grocer is willing to incur the transaction costs of keeping the store clean, heated and well lit.
How often does it happen, when you get to the cash and pay, both you and the grocer say thank you at the same time? Why not? You're both appreciative of the exchange; you both got something you valued more for something you valued less. You both are wealthier than you were before the exchange.
The result is that indeed total, aggregate social wealth has increased. Furthermore, this is not some anomaly but the guaranteed outcome of voluntary transactions. The secret of the free market economy is this win-win situation of voluntary exchange. And, the freer the market economy is, the greater the total social wealth that is generated.
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