Imagine you were part of an economy that has no government regulation whatsoever. Individuals are free to make economic decisions as they please. There would probably exist a couple of monopolies, such as pharmaceutical companies, that would increase the prices of life savings drugs by thousands of percent here and there, but the government would do nothing about it. Instead, it would leave economic agents to do as they please. In such a scenario, you would be living under laissez faire economics.
What are the benefits of such an economy, if any? How does this economy work? Should there be any government intervention, or should there simply be laissez faire economics?
Why don't you read on and find out the answers to these questions and all there is to know about laissez faire economics!
Laissez Faire Economics Definition
To understand laissez faire economics definition let's consider where the laissez faire comes from. Laissez faire is a French expression that translates to 'leave to do.' The expression is broadly interpreted as 'let people do as they will.'
The expression is used to refer to economic policies where the government's involvement in the economic decision of individuals is minimal. In other words, the government should 'let people do as they will' when it comes to an economic decision.
Laissez faire economics is an economic theory that suggests that the government should not intervene in the markets.
The main idea behind Laissez Faire economics is to advocate a free market economy without any government intervention.
If you need to refresh your knowledge of how the government can influence the market check out our article:
- Government Intervention in the Market!
- There are two main types of government intervention that laissez faire economics opposes:
- Antitrust laws;
- Protectionism.
- Antitrust laws. Antitrust laws are laws that regulate and reduce monopolies. Monopolies are markets where there is one seller, and the seller can influence and harm consumers by raising prices or restricting quantities. Laissez faire economics suggests that the firm that is the sole provider of the good should not be subject to antitrust laws. Allowing individuals to choose as they please will set the necessary market conditions that either enhance the firm's monopolistic power or decline it. In other words, the interaction between demand and supply will allocate the resources so that they are most efficient in producing and consuming the good.
- Protectionism. Protectionism is a government policy that reduces international trade, intending to protect local producers from international ones. While protectionist policies may protect local producers from international competition, they hinder overall growth in terms of real GDP. Laissez faire economics suggests that protectionism reduces competition in the market, which will increase local goods' prices, causing harm to consumers.
If you need to refresh your knowledge of monopoly or protectionist policies, check out our articles:
- Monopoly;
- Protectionism.
Laissez faire economics advocates that a natural order will regulate the markets, and this order will be the most efficient allocation of resources, which benefits all agents in the economy. You can think of the natural order as similar to the 'invisible hand' Adam Smith talked about when he argued in favor of the free market.
In laissez faire economics, the economy can adjust and regulate itself. Government intervention will only cause more harm than good.
If you need to refresh your knowledge on how the economy can adjust and regulate itself, our article on "Long-Run Self Adjustment" can help you out!
Laissez Faire Economics Policy
To understand laissez faire economic policy, we need to refer to consumer and producer surplus.
Fig. 1 - Producer and consumer surplus
Figure 1 shows the producer and consumer surplus.
Consumer surplus is the difference between how much consumers are willing to pay and how much they pay.
Producer surplus is the difference between the price at which producers sell a product and the minimum price they are willing to sell it for.
If you need to refresh your knowledge of consumer and producer surplus, check out our articles:
- Consumer Surplus;
- Producer Surplus.
Coming back to Figure 1. Notice that at point 1, the equilibrium between the demand and supply occurs. At this point, the consumer and producer surplus is maximized.
The equilibrium point provides where resources are allocated most efficiently in the economy. That's because the equilibrium price and quantity enable those consumers who value the good at the equilibrium price to meet those suppliers that can produce the good at the equilibrium price.
Confused about what exactly the word 'efficiency' means?
Don't worry; we have got you covered!
Simply click here: Market Efficiency.
The part of the demand curve from point 1 to point 3 represents those buyers that value the product less than the market price. Those suppliers who can't afford to produce and sell at the equilibrium price are part of the segment from point 1 to point 2 on the supply curve. Neither these buyers nor these sellers participate in the market.
The free market helps consumers match with sellers that can produce a certain good at the lowest cost possible.
But what if the government decided to change the quantity and the price for which the good is sold?
Fig. 2 - Value to buyers and cost to sellers
Figure 2 shows what happens if the total quantity produced is below or above the equilibrium point. The supply curve represents the cost to sellers, and the demand curve represents the value to buyers.
If the government decides to get involved and keep the quantity below the equilibrium level, the buyers' value is above the sellers' cost. That means that the consumers attach more value to the product than it costs suppliers to make it. This would push sellers to increase the total production, which would increase the quantity produced.
On the other hand, if the government decided to increase the quantity beyond the equilibrium level, the seller's cost would be way higher than the buyer's value. That's because, at this quantity level, the government would have to set a lower price to include the other people that would be willing to pay that price. But the trouble is those additional sellers that would have to enter the market to match the demand at this quantity face higher costs. This causes the quantity to drop to the equilibrium level.
Therefore, the market would be better off producing the equilibrium quantity and price where consumers and producers maximize their surplus and, therefore, social welfare.
Under laissez faire economics policy, where people are 'left to do as they will,' the market efficiently allocates resources. Simply put, the government policy in such a case would be considered undesirable.
Laissez Faire Economics Examples
There are many laissez faire economics examples. Let's consider a few!
Imagine that the United States federal government decided to remove all international trade restrictions. When nations do not impose any restrictions on trade with one another, this is an example of a laissez faire economic system.
For instance, the majority of countries impose a tax on imported goods, and the amount of that tax typically varies from product to product. Instead, when a country follows a laissez faire economics approach to trade, all taxes on imported goods would be waived. This would allow international suppliers to compete with local producers on a free-market basis.
Do you need to know more about how government limits international trade by using certain policies?
Then read our article on "Trade Barriers," which will help you out!
Another example of laissez faire economics is removing the minimum wage. Laissez faire economics suggests that no country should impose a minimum wage. Instead, the wage should be determined by the interaction of demand and supply for labor.
Want to learn more about wages and how they impact our lives and economies?
Click here: Wages.
Laissez Faire Economics Pros and Cons
There are many pros and cons of laissez faire economics. The main pros of laissez faire economics include higher investment, innovation, and competition. On the other hand, the main cons of laissez faire economics include negative externality, income inequality, and monopoly.
| Pros of Laissez Faire Economics |
- Higher investment. If the government doesn't get in the way of business, there won't be any laws or restrictions to keep them from investing. It makes it simpler for companies to purchase property, develop factories, recruit staff, and generate new items and services. It has a beneficial impact on the economy since companies are more ready and willing to invest in their future.
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- Innovation. As the interaction of demand and supply rules the economy, companies are compelled to be more creative and original in their approach to meet the demand and acquire market share from competitors. Innovation then plays an essential role in boosting the country's overall economic growth enabling everyone to benefit from it.
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- Competition. The lack of government regulations ensures that there is an increase in competition in the market. Companies constantly compete in terms of pricing and quantity, leading the demand to meet the supply at the most efficient point. Companies incapable of producing at lower costs will be forced out of the market, and companies that can make and sell at lower prices will remain. This enables a broad range of individuals to access certain goods.
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| Table 1 - Pros of Laissez Faire Economics |
| Cons of Laissez Faire Economics |
- Negative externalities. Negative externalities, which refer to costs faced by others resulting from a company's activities, are one of the most significant disadvantages of laissez faire economics. As the market is governed by demand and supply and the government has no say whatsoever, who is to stop companies from polluting the air or contaminating the water?
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- Income inequality. Laissez faire economics suggests that there is no government regulation at all. This would also mean that the government does not impose a minimum wage leading to a wider gap in the incomes of individuals in society.
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- Monopoly. As there are no government regulations, companies can gain market share through different business practices that the government cannot prevent. As such, these companies can increase prices to levels many individuals would not be able to afford, causing direct harm to consumers.
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| Table 2 - Cons of Laissez Faire Economics |
If you need to refresh your knowledge on each of the cons of laissez-faire economics, then click on these explanations:
- Negative externalities;
- Income Inequality;
- Monopoly.
Laissez Faire Economics Industrial Revolution
Laissez faire economics during the industrial revolution is one of the earliest economic theories developed.
The term came into light during the period of the Industrial Revolution in the late 18th century. French industrialists coined the term in response to the voluntary assistance provided by the French government to promote business.
The term was first used when the french minister asked industrialists in France what the government could do to help foster industry and growth in the economy. The industrialists at the time answered simply by saying, 'Leave us alone,' hence, the term 'laissez faire economics'.1
Industrialization was facilitated by the laissez faire economic philosophy, which advocated for the government having no role in, or as little role as possible in, the day-to-day operations of the nation's economy. It was successful in maintaining low tax rates while simultaneously encouraging private investment.
It was a significant factor that helped incentivize individuals to undertake business ventures and invent new industrial products. As the government was no longer involved in the market dictating economic decisions, individuals could interact on a demand-and-supply basis.
Laissez Faire Economics - Key takeaways
- Laissez faire economics is an economic theory that suggests that the government should not intervene in the markets.
- 'Laissez faire' is a French expression that translates to 'leave to do.'
- The main pros of laissez faire economics include higher investment, innovation, and competition.
- The main cons of laissez faire economics include negative externality, income inequality, and monopoly.
References
- OLL, Garnier on the Origin of the Term Laissez-faire, https://oll.libertyfund.org/page/garnier-on-the-origin-of-the-term-laissez-faire
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