Market (economics)

The uses of the term

The word "market" is commonly used to distinguish transactions between individuals from other ways of allocating goods and services. The term "market economy", for example, is often used to describe a society in which most business decisions are made by individuals and companies, rather than by the government - which, as a political regime, is generally known as capitalism. It is also used as a noun to refer to an institution that facilitates such transactions, and as a verb to denote the activity of promoting them.

The term "the market", has a different usage, however. That usage refers to a theoretical model of a process by which prices are determined by supply and demand (a graphical representation of which can be seen in most economics textbooks). That model depends entirely upon deduction from untested axioms, and, without empirical support, it has limited application to the real world. Empirical evidence indicates that, in fact, market behaviour is strongly influenced by the characteristics of the institutions within which trading takes place.

Market characteristics

The concept of "market structure" concerns the proportion of the items that are supplied that comes from a few suppliers, or the proportion of items acquired that go to a few purchasers. Its practical importance derives from its association with "market power", which is the ability to influence the prices at which items change hands. (The policy implications of market power are discussed below in the paragraph headed competition policy.) Measures of market structure include the 5-firm concentration ratio and the Herfindahl Index. Suppliers can increase their market power by mergers, restrictive trade practices or innovation.

Markets do not, by definition, exist for public goods (such as open spaces and lighthouses) that are not paid for by individual users because of the difficulty of restricting access or use. Where those difficulties can be overcome at a cost (as in road pricing), the cost of overcoming them is a relevant market characteristic.

The speed with which a market price responds to a sudden change in the supply of, or demand for, its product is termed its price flexibility. Price flexibility may be limited by search friction or by commercial or regulatory market constraints.

Markets also differ as to their stability. Instability can develop in markets that require the use of credit if circumstances, such as a demand shock, create a general fear of default. Fear of default can result in a reinforcing rise in the incidence of default - a continuing process that could lead to systemic market failure

The economics of the market

The basic concept

In economic theory, a market exists when a would-be buyer makes contact with a would-be seller for the purpose of agreeing an exchange. In his Principles of Economics Alfred Marshall offered several definitions and gave a range of examples .

Perfect markets

Marshall also introduced the concept of a perfect market when he wrote .. the more nearly perfect a market is, the stronger is the tendency for the same price to be paid for the same thing at the same time in all parts of the market. The hypothetical ideal of a perfect market has since been developed to mean a situation in which:

• price is determined by the costless interaction of collective supply with collective demand;
• all information that is relevant to the price of a commodity is immediately known to all market participants;
• all market participants act rationally;
• it is impossible for any individual participants or groups of participants to influence the price of a product.