For many economists, the collapse of the Soviet Union and the communist nations of Eastern Europe during the late 1980s and early 1990s was proof that a free market economy is preferable to a socialist system. A free market system decentralizes economic decision making and emphasizes private ownership of productive resources. Most economists regard a free market as the optimal system for organizing an economy.
A free market economy is based on private enterprise, in which individuals and companies rather than a central government authority own most of the resources used in production, such as land and capital. Economists use the word "market" to define not a physical location but an exchange mechanism that brings together buyers and sellers of goods, services, resources or factors of production.
Harvard economist N. Gregory Mankiw writes in "Principles of Economics" that free market economies often appear puzzling. A system in which consumers and producers pursue their own interests may lead an observer to ask how a free market economy succeeds when no single person or entity is looking out for society’s overall well-being. In his 1776 book “The Wealth of Nations,” Scottish economist Adam Smith offered insights into the success of market economies, writing that consumers and producers pursuing their own interests end up benefiting the overall society as if guided by what he called an invisible hand.
A decentralized economic system — one without centralized direction — means that transactions between buyers and sellers occur on a voluntary basis. The late economist Murray N. Rothbard, writing on the "Concise Encyclopedia of Economics" website, says buyers and sellers in a free market transact business because they each expect to gain from the activity. If buyers and sellers do not expect to benefit, Rothbard writes, the transaction does not take place.
Advocates of a free market economy emphasize that such a system maximizes individual liberty. Under a free market, individuals are free to deploy their talents and invest their resources in whatever occupation or enterprise they choose, rather than be subject to the direction of a government planner or other central authority. Further, the market system allows individuals to succeed as much as their initiative, talents and drive permit.
Because individuals and companies have the liberty to invest and produce as they wish, a free market economy enables consumers to have access to the broadest possible range of goods and services. Although different economies may choose to specialize in producing particular products based on their available resources, Mankiw points out that free trade, as part of a market economy, offers a greater array of goods for sale.
Although the free market economy delegates economic decisions to individuals and companies rather than to government planners, the government still has a role in a market economy. Mankiw writes that government acts as a kind of referee with a free market, enforcing property rights through the legal system. In addition, government intervenes by producing goods and services, such as national defense, that the market cannot provide.