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.

The main idea behind Laissez Faire economics is to advocate a free market economy without any government intervention.

• There are two main types of government intervention that laissez faire economics opposes:
  1. Antitrust laws;
  2. 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.

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.

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.

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.

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!

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.

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.