This is part of a series on Milton Friedman’s “Free to Choose.”

A couple weeks ago I wrote about the introduction to Free to Choose by Milton and Rose Friedman. In this post, I will explore some of the points from the first chapter, “The Power of the Market.”

Friedman begins the chapter by explaining the difference between a command and a voluntary economy. Like a military, there is a chain of commands that take place. Yet the general cannot be entirely accountable for everything that a private does. That is why “commands must be supplemented by voluntary cooperation,” which is a more fundamental technique of coordinating activities. Friedman argues that there is no society that operates entirely on the command method or the voluntary method. Even in the Soviet Union there were moonlighters who would take extra pay to fix a household problem same day than for the homeowner to wait months for the government.

The market functions in not-so-obvious ways. Leonard E. Read wrote a story about how a pencil is made, from the forests of northwestern America to the factories in Indonesia. Yet at the store, we exchange some of our money for some pencils. Astoundingly, “no one sitting in a central office gave orders to these thousands of people” and “no military police enforced the orders that were not given.” How could this be? Adam Smith understood this clearly: “if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it.” Smith observed that in a free market, buyers and sellers would coordinate together voluntarily to make everyone better off. Economic order emerges from individuals seeking their own interest.

The price system that forms helps to naturally regulate the market in three ways: transmits information, incentivizes price efficiency and distributes income.

1. Transmits information: Only necessary information is transmitted between buyer and sellers. This includes information of changes in demand and supply but not causes of the changes. “A major problem in transmitting information efficiently is to make sure that everyone who can use the information gets it without clogging the ‘in’ baskets of those who have no use for it.” The price system naturally solves the problem because the people who are looking for the information search it out to better their situation. From the consumer’s perspective, this explains why I spend so much time looking for good deals between different grocery stores! However, the government can also me a major source of interference with the natural market when it sets tariffs on international trade, fixes wages and prices, regulates certain industries, and produces erratic inflation.

2. Incentivizes price efficiency: Understanding incentives was the easiest of the three natural regulations for me to grasp. As consumers, if there is a high price for an item, we tend to economize as much as we can to get our money’s worth. My wife is always getting on to me for trying to penny-pinch, and that’s more true for the larger purchases we make. But producers also have incentives when it comes to running a business. They want to run a business as cheaply as possible to maximize their profit. Additionally, workers consider incentives. “Satisfaction in a job may compensate for low wages. On the other hand, higher wages may compensate for a disagreeable job.”

3. Distributes income: Lastly, the market redistributes wealth in a natural way. Some people are unhappy with the distribution of wealth and so look to where they think the grass is greener. “In a command system envy and dissatisfaction are directed at the rulers. In a free market system they are directed at the markets.”  However, “fixing” the free market causes disincentives and leads to inefficiencies of wealth growth. The command system is worse. Workers are unhappy when bureaucracies tell them what to do and when the government builds things, nobody takes responsibility for them: “when everybody owns something, nobody owns it, and nobody has a direct interest in maintaining or improving its condition.” The command system does not transmit information or incentivize as efficiently as the free market, and it distorts the incentives for various income distributions.

Next time I’ll explain the role of a government in a free market. 

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Uploaded by ReasonTV on Sep 29, 2008