Friedman passed away at his home in San Francisco, near Stanford University where he taught most recently, Cato Institute spokesman Jamie Dettmer said. The Wall Street Journal reported the cause of death as heart failure.
Friedman won the Nobel prize for economics in 1976 and his thinking greatly influenced the policies of former US president Ronald Reagan and ex-British prime minister Margaret Thatcher.
From 1946 to 1976 he taught economics at the University of Chicago, a bastion of free-market thinking, and remained a professor emeritus there. He was also a senior figure at Cato, a libertarian think-tank in Washington.
Cato president Edward Crane remarked that Friedman, who coined the phrase, "There's no such thing as a free lunch", earned fame as a Nobel prize winner and a great theoretician of economics.
"But ultimately, what Milton believed in was human liberty and he took great joy in trying to promote that concept," he said.
"In my view he was the greatest champion of human liberty in my lifetime, certainly in the 20th century. And he didn't slack off in the 21st century."
Friedman's work was often contrasted with British economist John Maynard Keynes, whose belief in the necessity for governments to intervene in times of economic strife dominated policy thinking from the 1920s to the 1960s.
Rejecting the Keynesian model, both Thatcher and Reagan used the Friedman school to help inform their vision of small government and free-market policies.
"Governments never learn. Only people learn," Friedman once remarked. "I am in favour of cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible."
Friedman was born on July 31, 1912 in New York, the youngest of four children to Jewish immigrants from what is now Ukraine.
He received his bachelor of arts degree in 1932 from Rutgers University, a master of arts degree in 1933 from the University of Chicago, and a doctorate in 1946 from Columbia University.
Friedman's views were shaped by the Great Depression, and his writings blaming the Federal Reserve for deepening the crisis by choking off the money supply gained wide acceptance.
"He correctly predicted the rise in inflation in the 1960s and 1970s -- something that Keynesian analysts missed," said economist Nariman Behravesh at Global Insight.
"His monograph on the monetary history of the United States outlined the culpability of the Fed in exacerbating -- if not triggering -- the Great Depression. It continues to be widely read and quoted by many economists today, including (current Fed chairman) Ben Bernanke."
Friedman was an advisor to Republican presidents including Richard Nixon and Reagan. His "monetarist" theories emphasised the crucial importance of using the money supply to get a grip on inflation, and thus put economies on a stable footing.
A prolific writer, his books included "Capitalism and Freedom" and, co-written with his wife Rose, "Free to Choose" and "Tyranny of the Status Quo", which both accompanied television series.
He also contributed columns to Newsweek magazine between 1966 and 1984 which helped to popularise the ideas that took shape in government policy on both sides of the Atlantic.
In 1988, he was awarded the Presidential Medal of Freedom, one of the two highest civilian awards in the United States.
He and his wife established the Milton and Rose D. Friedman Foundation, to promote parents' right to choose the schools their children attend, at Indianapolis, Indiana.
"America has lost a true visionary and advocate for human freedom. And I have lost a great friend," lamented the foundation's president, Gordon St Angelo.
"Milton's passion for freedom and liberty has influenced more lives than he ever could possibly know," he said.
"His writings and ideas have transformed the minds of US presidents, world leaders, entrepreneurs and freshmen economic majors alike. "The loss of his passion, incisive mind and dedication to freedom are all national treasures that we mourn for today."

Copyright AFP (Agence France-Presse), 2006