Open Market

An economic situation that resembles free trade

Author: Christy Grimste
Christy Grimste
Christy Grimste
Real Estate | Investment Property Sales

Christy currently works as a senior associate for EdR Trust, a publicly traded multi-family REIT. Prior to joining EdR Trust, Christy works for CBRE in investment property sales. Before completing her MBA and breaking into finance, Christy founded and education startup in which she actively pursued for seven years and works as an internal auditor for the U.S. Department of State and CIA.

Christy has a Bachelor of Arts from the University of Maryland and a Master of Business Administrations from the University of London.

Reviewed By: Sid Arora
Sid Arora
Sid Arora
Investment Banking | Hedge Fund | Private Equity

Currently an investment analyst focused on the TMT sector at 1818 Partners (a New York Based Hedge Fund), Sid previously worked in private equity at BV Investment Partners and BBH Capital Partners and prior to that in investment banking at UBS.

Sid holds a BS from The Tepper School of Business at Carnegie Mellon.

Last Updated:September 30, 2023

What Is an Open Market?

It refers to an economic situation that resembles free trade. This implies that companies can trade freely without government-imposed limits or trade barriers.

In such an economic system, buyers and sellers can freely trade due to little or no market barriers. Moreover, the market is accessible to all economic agents as they all have an equal opportunity to enter the market. 

Common market barriers include taxes, subsidies, unfair licensing agreementstariffsunionization, and all other regulations that interfere in market activities. These market barriers, if enforced, act as barriers to entry into international trade

The prices of goods and services are set according to the free market mechanism; that is, the forces of demand and supply determine them. Goods with higher demand than supply are priced higher in the market than goods with a higher supply than demand.

It is essential to understand that the degree of 'openness' in a market is determined by the extent of government regulations and influence on trade. It is not a bivariate concept but a relative one. 

An economy can be less than fully open due to minimal interference by the government. However, in the modern world, there are no fully open economies as a market cannot function without a legal framework to protect the interests of buyers and sellers from unfair market practices.

Regulations in the modern world are necessary to ensure the standard of services, quality of goods, and transaction compliance. Restrictions are placed on producing and distributing certain drugs and harmful products like cigarettes and liquor.

The United States, Canada, and Australia are close to free-market economies. 

Due to many competitors and key players, there may be competitive barriers to entry. For instance, without government intervention, a new tech startup would find it difficult to compete with major players like Google, Oracle, and Microsoft.

An open market system follows free trade policies to avoid discrimination between imports and exports. Every trader wishing to sell a good or service can do so without facing any selling charges or taxes.

The US stock market is a typical example of an open market. All investors are free to trade and are offered the same price depending on the market forces.

Open Market vs. Closed Market

The opposite of an open market system is a closed market system. A fast market is restricted by government-imposed regulations like tariffs, taxes, import duties, quotas, etc.

It also includes cultural norms or other influencing mechanisms restricting free market activity. For instance, prohibition laws prohibit the manufacturing and distribution activities related to alcohol. Similarly, religious influences may also restrict market activity.

Closed markets involve any situation where people cannot freely indulge in trading activities, and the price is not set according to market mechanisms.

A typical example is the enforcement of binding price floors and price ceilings wherein the government sets a minimum or maximum price level for a commodity. As a result, the producers are forced to set prices accordingly.

The minimum wage concept is an example of a price floor set by the government to protect the interest of laborers. Unfortunately, this regulation of wages in the market leads to less demand for labor in the market as producers are unwilling to pay higher than the equilibrium wage rate.

This reduction in demand for labor increases unemployment and forces workers to work for less than minimum wages in a black market system.

While closed market mechanisms are detrimental to the economic agents' interests, governments opt for these measures to protect a large section of people.

For example, international trade barriers and import duties are enforced by governments to protect the interests of domestic producers from highly-efficient global traders. In addition, this protects small domestic traders from unfair competition by international market players. 

A closed market is also called a protectionist market based on protecting domestic agents. Some examples of protectionist markets include North Korea and Cuba.

The restrictions placed by the government can take two forms: 

  • Pricing restrictions affect the price of goods through tariffs, taxes, and various duties. A common practice is to charge import duties to discourage the sale of foreign commodities in the domestic economy.
  • Participation restrictions dictate who can enter the market. It involves restricting sellers or buyers in a market.

A typical example is the Middle Eastern market system, where foreign companies can only compete in the local market if they have a 'sponsor' or a native citizen owning a certain percentage of the business. 

It is empirically proven that free-market systems show higher economic growth than closed-market systems. Furthermore, due to the size of the market and the large number of resources involved, the level of economic activities and volume of trade are more significant in free markets.

This means citizens in such economies enjoy higher living standards, better infrastructure, more vital institutions, innovation, and higher productivity. This also reduces instances of poverty in such countries.

Most developed countries are relatively more open than undeveloped and developing countries.

Example of an Open Market

Following are a few of the free-market organizations:

1. The European Union

It is a political and economic union of 27 member states located primarily in Europe. One of the founding principles of the European Union was free trade among member countries. To that effect, it is the world's largest single market area. 

It is considered to compromise the most outward-oriented economies of the world. The EU represents each member country while negotiating trade agreements and thus has more power in international trade than members would have individually.

The European Union represents the rights of European exporters by providing them access to world markets. It works to remove trade barriers while simultaneously helping foreign companies access the European market. 

The EU facilitates free-market activities among its member nations by adopting a single currency, the euro. This reduces transaction costs and provides ease of doing business and trade.

2. The World Trade Organization(WTO)

Another such organization is the WTO-World Trade Organization which aims to regulate trade among member countries. Lowering trade barriers and managing lines of communication among countries helps promote international business.

It has also enforced trade barriers to protect economic agents' interests. A typical example is the enforcement of trade barriers on disruptive elements in international trade like China and North Korea.

It keeps global trade running smoothly and facilitates the resolution of disputes among members.

The workings of the EU and WTO have undoubtedly benefited multinational companies with high stakes in the global economy. However, it has also negatively impacted domestic economies due to reduced employment opportunities and unfair competition. 

Researched and authored by Manya Bhardwaj | LinkedIn

Reviewed & Edited by Ankit SinhaLinkedIn

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