Thesis #18

Thesis 18: The free market was always an illusion. In Cyberspace it’s a fraud.

In economic theory a free market is an idealised system in which the prices for goods and services are determined by the open market and consumers, in which the laws and forces of supply and demand are free from any intervention by a government, price-setting monopoly, or other authority. The unobservable force that enables the demand and supply automatically to reach equilibrium was christened “the invisible hand” by Adam Smith in his 1776 book ‘The Wealth of Nations’.

The attraction of the free market as a theoretical concept is that it provides the most efficient way of allocating resources. Prices automatically adjust until supply exactly matches demand. But for such an idealised system to exist, all kinds of conditions would have to be met. For example:

  • There must be perfect competition – competitors are indistinguishable from one another and their products are completely interchangeable
  • Buyers and sellers must have all the relevant information on their product and the market — there must be none of the ‘information asymmetry’ that exists, say, in the used-car market as described in George Akerlof’s famous article on “Markets for Lemons”
  • There must be no lag times and no barriers to entry to the market. And there should be free flow of capital, resources, and labour.
  • There must be no collusion between buyers’ decisions to buy and producers’ decisions to sell.

In real life, these (and related) conditions are rarely met and so the truly free market remains just a theoretical construct — i.e. a consensual illusion of a particular profession.

In the early days of the Web, people thought that because a competitor was always “just one click away” the technology would usher in an era of free, ‘frictionless’ markets and perfect competition. The fact that buyers could also carry out their own checks (e.g. by reading customer reviews, consulting consumer discussion fora, etc.) would mean that information asymmetries would be eliminated or reduced, there would be no more “markets for lemons”, and so on.

It didn’t happen. Instead what we got was virtual competition with markets orchestrated by opaque price-setting algorithms which use machine-learning techniques on user data to reach judgements about what each individual might be willing to pay. A customer buying an airline ticket using a computer with an Indian IP address, for example, may be quoted a different price from that offered to a consumer booking the same seat from a US-based computer, for example. Online markets may have the surface appearance of real-world markets, but they are driven by different forces. As two leading competition lawyers put it, “The good old ‘invisible hand’ of competition that safeguarded our welfare when we shopped in our local fruit market, is being displaced by the digitalised hand” and so power has shifted to the companies that control its algorithms.

Further reading

Wikipedia, Free Market

Bernard Harcourt, The Illusion of Free Markets, Harvard, 2012.

Ariel Ezrachi and Maurice Stucke, Virtual Competition: The Promise and Perils of the Algorithm-Driven Economy, Harvard, 2016.

George Akerlof, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism”, The Quarterly Journal of Economics, Vol. 84, March 2008. Available online

Michael Eisen, “Amazon’s $23,698,655.93 book about flies”, 22 April 2011,