# Free Market Definition and Impact on the Economy

> **Definition**
>
> A free market is an economy with minimal or no government control of supply, demand, or prices.

## What Is a Free Market?

The free market is an economic system based on supply and demand with little or no government control. One of the central principles of a free market is the concept of voluntary exchange, which is defined as any transaction in which two parties freely trade goods or services.

Free markets are characterized by a spontaneous and decentralized order of arrangements through which individuals make economic decisions.

### Key Takeaways

*   A free market is one where the laws of supply and demand provide the sole basis for the economic system, without government intervention.
*   A core tenet of free markets is the idea of voluntary exchange, transactions in which buyers and sellers freely trade goods and services.
*   While no pure free market economies actually exist, and all markets are in some ways constrained, economists who measure the degree of freedom in markets have found a generally positive relationship between free markets and measures of economic well-being.

![Free Market](https://www.investopedia.com/thmb/_9XkVNib9uChdohqvFuZRjOyGjk=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/freemarket-3d08a58261b840feadd03dcdd5c76ac2.jpg)

*— Investopedia / Julie Bang*

## Understanding Free Markets

The term “free market” is sometimes used as a synonym for laissez-faire capitalism. When most people discuss the “free market,” they mean an economy with unobstructed competition and only private transactions between buyers and sellers. However, a more inclusive definition should include any voluntary economic activity so long as it is not controlled by coercive central authorities.

Using this description, [laissez-faire](https://www.investopedia.com/terms/l/laissezfaire.asp) capitalism and voluntary [socialism](https://www.investopedia.com/terms/s/socialism.asp) are each examples of a free market, even though the latter includes common ownership of the means of production. The critical feature is the absence of coercive impositions or restrictions regarding economic activity. Coercion may only take place in a free market by prior mutual agreement in a voluntary contract, such as contractual remedies enforced by tort law.

## The Free Market's Connection With Capitalism and Individual Liberty

No modern country operates with completely uninhibited free markets. That said, the most free markets tend to coincide with countries that value private property, capitalism, and individual rights. This makes sense since political systems that shy away from regulations or subsidies for individual behavior necessarily interfere less with voluntary economic transactions. Additionally, free markets are more likely to grow and thrive in a system where property rights are well-protected and capitalists have an incentive to pursue profits.

## Free Markets and Financial Markets

In free markets, a financial market can develop to facilitate financing needs for those who cannot or do not want to self-finance. For example, some individuals or businesses specialize in acquiring savings by consistently not consuming all of their present wealth. Others specialize in deploying savings in pursuit of entrepreneurial activity, such as starting or expanding a business. These actors can benefit from trading financial securities such as stocks and bonds.

For example, savers can purchase bonds and trade their present savings to entrepreneurs for the promise of future savings plus remuneration, or interest. With stocks, savings are traded for an ownership claim on future earnings. There are no modern examples of purely free financial markets.

## Common Constraints on the Free Market

All constraints on the free market use implicit or explicit threats of force. Common examples include: prohibition of specific exchanges, taxation, regulations, mandates on specific terms within an exchange, licensing requirements, fixed exchange rates, competition from publicly provided services, price controls, and quotas on production, purchases of goods, or employee hiring practices.

Common justifications for politically imposed constraints on free markets include consumer safety, fairness between various advantaged or disadvantaged groups in society, and the provision of public goods. Whatever the outward justification, business firms and other interest groups within society often lobby to shape these constraints in their own favor in a phenomenon known as rent-seeking. When free market behavior is regulated, the scope of the free market is curtailed but usually not eliminated entirely, and voluntary exchanges may still take place within the framework of government regulations.

## Measuring Economic Freedom

To study the effects of free markets on the economy, economists have devised several well-known [indexes of economic freedom](https://www.investopedia.com/terms/i/index-of-economic-freedom.asp). These include the Index of Economic Freedom published by the Heritage Foundation, and the Economic Freedom of the World and Economic Freedom of North America indexes published by the Fraser Institute. These indexes include items such as the security of property rights, the burden of regulation, and the openness of financial markets, and others. Empirical analysis comparing these indexes to various measures of economic growth, development, and standards of living shows overwhelming evidence of a relationship between free markets and material well-being across countries.

## What Is a Free Market in Simple Terms?

Free markets are economies where governments do not control prices, supply, or demand or interfere in market activity. Market participants are the ones who ultimately control the market.

## Is Free Market the Same as Capitalism?

Capitalism is a form of free market, sharing some similarities, but they are not the same. Governments are involved in regulating private and public businesses and implementing fiscal and monetary policies to influence economic activity.

## Is Free Market a Good Thing?

A completely free market is a theoretical environment, with most markets combining aspects of other types. These combination markets tend to allow privacy in ownership and individualism rather than allowing markets to exist without any controls.

## The Bottom Line

A free market is one where voluntary exchange and the laws of supply and demand are the basis for the economic system. Crucially, a free market is defined by the absence of government control. While no modern country has a completely free market, those that have relatively free markets tend to value private property, capitalism, and individual liberties.

> **Article Sources**
>
> 1.  International Monetary Fund. "[What Is Capitalism?](https://www.imf.org/external/pubs/ft/fandd/2015/06/basics.htm)"
>     
> 2.  Cato Institute. "[On Libertarian Socialism](https://www.libertarianism.org/columns/libertarian-socialism)."
>     
> 3.  The Heritage Foundation. "[Index of Economic Freedom](https://www.heritage.org/index/about)."
>     
> 4.  The Fraser Institute. "[Economic Freedom of the World: 2024 Annual Report](https://www.fraserinstitute.org/categories/economic-freedom-world)."
>     
> 5.  The Fraser Institute. "[Economic Freedom of North America 2024](https://www.fraserinstitute.org/categories/economic-freedom-north-america)."