Understanding the concept behind the free market economy

The financial meltdown only accelerated these trends, bringing new urgency to the challenge of restoring and expanding middle-class living standards in the twenty-first century economy. The challenges facing ordinary working Americans are sharply etched in public opinion surveys, the news media, and everyday life in our communities, but our political leaders remain deeply divided about how to solve the problems. At the heart of this debate, there is a basic question: What is the role of government in our economy?

Understanding the concept behind the free market economy

A commonly held belief — on Main Street as well as on Wall Street — is that a stock-market boom is the reflection of a progressing economy: A major assumption underlying this belief is that consumer confidence and consequent consumer spending are drivers of economic growth. A stock-market bust, on the other hand, is held to result from a drop in consumer and business confidence and spending — due to inflation, rising oil prices, high interest rates, etc.

Whatever the supposed cause, in the common view a weakening economy results in falling company revenues and lower-than-expected future earnings, resulting in falling intrinsic values and falling stock prices.

This understanding of bull and bear markets, while held by academics, investment professionals, and individual investors alike, is technically correct if viewed superficially but is substantially misconceived because it is based on faulty finance and economic theory.

Understanding the concept behind the free market economy

In fact, the only real force that ultimately makes the stock market or any market rise and, to a large extent, fall over the longer term is simply changes in the quantity of money and the volume of spending in the economy.

Stocks rise when there is inflation of the money supply i. This truth has many consequences that should be considered. Since stock markets can fall — and fall Understanding the concept behind the free market economy — to various degrees for numerous reasons including a decline in the quantity of money and spendingour focus here will be only on why they are able to rise in a sustained fashion over the longer term.

The Fundamental Source of All Rising Prices For perspective, let's put stock prices aside for a moment and make sure first to understand how aggregate consumer prices rise. In short, overall prices can rise only if the quantity of money in the economy increases faster than the quantity of goods and services.

In economically retrogressing countries, prices can rise when the supply of goods diminishes while the supply of money remains the same, or even rises. When the supply of goods and services rises faster than the supply of money — as happened during most of the s — the unit price of each good or service falls, since a given supply of money has to buy, or "cover," an increasing supply of goods or services.

George Reisman offers us the critical formula for the derivation of economy-wide prices: The formula shows us that it is mathematically impossible for aggregate prices to rise by any means other than 1 increasing demand, or 2 decreasing supply; i.

In our developed economy, the supply of goods is not decreasing, or at least not at enough of a pace to raise prices at the usual rate of 3—4 percent per year; prices are rising due to more money entering the marketplace.

The same price formula noted above can equally be applied to asset prices — stocks, bonds, commodities, houses, oil, fine art, etc. It also pertains to corporate revenues and profits.

As Fritz Machlup states: It is impossible for the profits of all or of the majority of enterprises to rise without an increase in the effective monetary circulation through the creation of new credit or dishoarding.

There are other ways the market could go higher, but their effects are temporary. For example, an increase in net savings involving less money spent on consumer goods and more invested in the stock market resulting in lower prices of consumer goods could send stock prices higher, but only by the specific extent of the new savings, assuming all of it is redirected to the stock market.

The same applies to reduced tax rates.

Keynesian economics - Wikipedia

These would be temporary effects resulting in a finite and terminal increase in stock prices. Money coming off the "sidelines" could also lift the market, but once all sideline money was inserted into the market, there would be no more funds with which to bid prices higher.

The only source of ongoing fuel that could propel the market — any asset market — higher is new and additional bank credit. As Machlup writes, If it were not for the elasticity of bank credit … a boom in security values could not last for any length of time.The free market economy is a system devised to resolve the basic economic problem (resources having to be allocated to many competing users that have infinite wants) through the market mechanism.

The centrally planned economy is an economic system where government go through detailed planni. A solid understanding of economics helps build a strong foundation in almost every area of life.

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Here are 5 economic concepts consumers need to know. It is the most basic concept in economics. The same concept would apply to the stock market: if there were a constant amount of money in the economy, the sum total of all shares of all stocks taken together (or a stock index) could not increase.

Keynesian economics (/ Keynesian economists generally advocate a managed market economy who recognised the significance of a slightly different concept.

If the economy is in a position such that the liquidity preference curve is almost vertical. BibMe Free Bibliography & Citation Maker - MLA, APA, Chicago, Harvard. The basic concept behind free-market economics is simple and seductive: the government should not attempt to pick winners by granting assistance to specific industries, and it should only intervene in the marketplace when there has been a substantial market failure.

Socialist market economy - Wikipedia