2.12 The market's inability to achieve equity

Free markets can distribute gains unevenly.

Prices coordinate voluntary exchange, but initial assets, bargaining power, education and discrimination shape who receives income and opportunity.

Example

A rise in demand for a scarce skill can increase wages for trained workers while leaving others behind even as total output grows.

Separate efficiency from equity: identify the market outcome, then examine distribution and the policy trade-off.

‘Free’ does not mean fair or costless; externalities, unequal starting positions and missing markets can change the judgement.

In a circular-flow diagram, households supply labour, land, capital and entrepreneurship to firms and receive wages, rent, interest and profit; firms receive consumption spending in return for goods and services. Households owning more productive assets or scarce skills receive larger factor incomes, can save and acquire further wealth, and may pass advantages to later periods. Low-income households have less saving capacity and may rely mainly on lower-paid labour, so the free-market flow can reinforce unequal income and wealth even when markets clear.