Although I taught basic economics for 16 years, I am not an economist. So all I can do in this letter is broadly explain how the "free market" works and the role that government must play to keep it as stable as possible.
The fact is that the market is not really free. One of the government's many roles is to either prohibit monopolies or to control necessary monopolies like those that produce needed services such as water, electricity, etc. through the Public Service Commission.
The PSC, not the market, decides what price these monopolies can charge the public.
Another reason the market is not free is because the balance of power between supply (producers) and demand (buyers) is never equal. Ideally the producers supply goods and services based on the amount buyers are willing to buy at an agreed upon price.
When producers produce more than demand, they have a surplus and must lower the price resulting in "sales" to bring back equilibrium. When the demands exceeds the supply (shortage) the price rises as buyers compete with each other.
Obviously, stability rests on the amount of money in circulation, i.e. the buyers must have enough money to buy what the producers produce and the producers must be able to buy the labor and materials they need. In other words, both must have income, and that income is determined by the amount of spending.
Obviously, every time someone spends a dollar someone else receives income. In addition, each time that same dollar is used to buy more goods and services or labor and materials, income increases throughout the economy (result of the "multiplier principle".)
The government has a crucial role to play to keep the market as stable as possible. Without controls the market will not be able to stabilize quickly. Left to the market it will either allow prices to rise (inflation) until the shortage is reduced or allow prices to fall (recession/depression) until demand buys up the surplus.
The government's role is to bring about stability before the market's extremes are reached.
This they can do by adjusting the amount of money in circulation. To do this they have two tools - fiscal policy and monetary policy.
In my next letter I will do my best to explain how these tools are used.