In a world of scarce resources and unlimited wants, individuals are forced to prioritize their wants and needs. Two main mechanisms exist in which a society can use to allocate resources, government and markets.
Government allocation of resources consists of centrally planning the economy from a top-down approach. This involves government officials making decisions on investments, production, prices etc. There are varied levels of involvement that the government can utilize to manage an economy. These range from complete control of resource allocation and the mode of production to a much more modest approach involving the mixed economies of Europe and the United States. However, there are definite tradeoffs to government intervention in the economy.
Friedrich Hayek, Nobel Laureate economist, warns that government intervention removes an individual’s freedom over economic decisions as governments decide taxation, wealth redistribution and more. Hayek emphasizes yet another significant tradeoff of government intervention. Stringent government controls of the economy result in an inefficient allocation of resources in the form of shortages and surpluses. Government is unable to efficiently calculate the fluctuations of supply and demand for the general welfare of the public . Political scientist Tom Palmer asserts that government interventions even in the form of regulations, mandates, and service delivery (mixed economy policy tools) often result in market distortions with dire consequences. The distortions and imbalances from government intervention result in undesirable black markets, corruption, and departure from the rule of law.
Markets are the alternatives to government intervention in the economy. Conversely, a market system is a bottom-up approach as individuals are in control of their own economic decision-making. The market system works on the basis of individual property rights and trade. Producers and consumers come together in a marketplace to freely exchange goods and services on the basis of supply and demand. Exchange in the market system is based on mutual consent of buyers and sellers as opposed to government coercion. Market exchange is the creation of wealth as trades signify that each party in a transaction stands to gain from cooperation. The market economy aligns self-interest into socially desirable outcomes as profit incentives drive innovation, customer satisfaction, and efficient allocations of scarce resources.
The price system is the market’s signaling method that represents the value of a good or service and its scarcity. Prices alter consumption and production behavior and constantly allow for adjustments to market equilibrium, where supply and demand intersect. The market system has been proven time and time again to be better for individual economic and political freedom and its implications on the wealth of nations have proven to the superior mode of resource allocation. However, it is important to note that there is a limited role for government within a market economy. The government must act as the legal enforcers of property rights and contracts.
The importance of prices are well explained in these two videos by Daniel Smith, Professor of Economics at Troy University. For those interested in learning more about the philosophy of individual freedom and market economics, www.learnliberty.org is a valuable resource containing videos and lectures that cover a wide array of economic, political, and philosophical topics. Learn Liberty is an educational project by the Institute for Humane Studies.