Voluntary Exchange and Competition

Mutually voluntary exchange is the best example of a win-win situation. Whenever a bilateral exchange occurs, both parties must profit, for if not, one party would simply have refused to trade. This basic result is sometimes used to argue that a free market economy, consisting of billions or trillions of bilateral voluntary exchanges, must therefore be to the benefit of everyone. In one sense this is true, but upon a more careful investigation, it is also misleading. To clarify the distinction, this chapter will explain in some detail how competitive markets are likely to work. However, the competitive process we need to understand is not the “perfect competition” described in standard economic models. Rather, we need to understand dynamic competition as described by Joseph Schumpeter (1942) when he talked about creative destruction. For Schumpeter, the crucial economic dynamic was one in which new businesses rise up in a creative process while existing businesses are simultaneously destroyed. Friedrich Hayek described this same dynamic competition when he discussed competition as a discovery process and the free market as a “spontaneous economic order.”1