Market (economics): Difference between revisions

From Citizendium
Jump to navigation Jump to search
imported>Nick Gardner
(Perfect markets)
mNo edit summary
 
(67 intermediate revisions by 4 users not shown)
Line 1: Line 1:
{{subpages}}
{{subpages}}
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 <ref>[http://www.econlib.org/library/Marshall/marP.html Alfred Marshall ''Principles of Economics'' Book V Chapter1 Macmillan 1920]</ref>.  
{{TOC|right}}
A '''market''' is a social construct that  enables sellers to trade with buyers. Markets provide the means of conveying  information about products from sellers to potential buyers, and of information about the demand for  products from  buyers to potential sellers. They also provide for mutual confidence among traders that their bargains will be met.


==Perfect markets==
==The uses of the term==
In political usage, 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 (sociology)|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.
 
In economics, the term  refers to a theoretical [[Model (theory)|model]] of a process by which prices are determined by [[Supply and demand|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. Market behaviour is known to be influenced  by the characteristics  of the institutions within which trading takes place.
 
==Market characteristics==
Markets can be categorised by their openness, structure, flexibility, stability, their degree of information asymmetry, and the difficulty of restricting access.
 
The term openness is here used to denote freedom from regulations concerning, for example, prices.  quality and permission to trade.
 
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 [[Market (economics)#Competition policy|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.
 
The  concept of market [[Price flexibility|flexibility]] is concerned with the speed with which a market price responds to a sudden change in the supply of, or demand for, its product. Flexibility may be limited by [[search friction]] or by commercial or regulatory [[Competition policy#Vertical constraints|market constraints]].
 
Markets also differ as to their [[Stability (economics)|stability]]. Instability can develop in markets that require the use of [[credit (finance)|credit]] if circumstances, such as a [[demand shock]],  create  a general  fear of [[default (finance)|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]].
 
[[Asymmetric information|Information asymmetry]] occurs when the seller has information about the subject of a bargain that is not available to the buyer.
 
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.
 
==Market organisation==
The term "primary market" refers to one of a variety of organisational arrangements in which buyers deal directly with sellers. All early markets were of that sort. A later development was the creation of "secondary markets" in which transactions are made between specialist "dealers", acting on behalf of prospective buyers and sellers. One way of organising a primary market is to bring together numbers  of mutually independent sellers with numbers of  mutually independent buyers, either by attending a physical market place, or by using a telephonic or electronic communications centre.  Another  is  to arrange an "auction", in which competing bids for the purchase of goods are made by groups of mutually independent buyers.  There are many different ways of organising  auctions, and they, too, can involve either attendance or  communication.
 
The traditional way of organising a secondary market involved a physical location (termed an "exchange" or a "pit"),  at which dealers matched [[ask price]]s with [[bid price]]s by "open outcry". That organisational form has now been replaced almost everywhere by the use of telephonic or electronic communication.  The term "electronic market" has come to denote the use of computer software to make bargains automatically by electronically matching ask prices and bid prices. [[Settlement (finance)|Settlement]], involving the transfer of payments and purchases, takes place after the completion of bargains, and is usually the work of [[clearing house]]s.
 
==Commercial markets==
{|align="center" cellpadding="5" style="background:lightgray; width:95%; border: 1px solid #aaa; margin:10px; font-size: 92%;"
| More detailed information about the operation of commercial markets is available in the [[financial system#Markets|article on financial system]].
|}
===Stock exchanges===
The major stock exchanges provide for regulated trading in [[security (finance)|securities]] that comply with regulations termed "listing". Many of them also  provide second-level markets for the shares of smaller firms (such as London's "Alternative Investment Market<ref>[http://www.londonstockexchange.com/en-gb/products/companyservices/ourmarkets/aim_new/AIM "London Stock Exchange AIM"]</ref>)
===Commodity markets===
Commodity markets are exchanges where commodities of standardised quality are traded using standardised contracts. (Commodities are  physical goods such as crude oil, and  metals). More than forty  commodity exchanges worldwide trade in over 100 commodities. Trading is confined to members and is commonly by "open outcry".
===Foreign exchange markets===
National currencies are traded against each other in countries all over the world and the  transactions are facilitated by multiple clearance systems<ref>[http://www.streetdirectory.com/travel_guide/185617/foreign_exchange/payment_and_settlement_systems_in_the_forex_market.html Donald Saunders: ''Payment and Settlement Systems in the Forex Market'', Streetdirectory.com, 2009]</ref>.
The activities of the traders in the different countries interact so strongly that the system behaves as though all trading were done in one centrally-administered exchange.
 
==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.  It embodies a concept of the process by which the [[supply and demand]] for a commodity, product  or service are brought into equality. In the late 19th century, the English economist [[Alfred  Marshall]] offered several definitions and gave a range of examples <ref>[http://www.econlib.org/library/Marshall/marP.html Alfred Marshall ''Principles of Economics'' Book V Chapter1 Macmillan 1920]</ref>.
 
===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:
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;
* price is determined by the costless interaction of collective supply with collective demand;
Line 8: Line 51:
* all market participants act rationally;
* all market participants act rationally;
* it is impossible for any individual  participants or groups of participants to influence the price of a product.
* it is impossible for any individual  participants or groups of participants to influence the price of a product.
The implications of the concept were explored in the 20th century by a mathematical exploration of the behaviour of a universal system of interconnected perfect markets in a condition of [[general equilibrium]]. The resulting  [[Welfare economics#The welfare theorems|theorems of welfare economics]] demonstrated  that such a system would achieve a limited form of [[economic efficiency]] termed [[Pareto efficiency]]. That demonstration has been widely interpreted to imply that in practice  the removal of obstacles to the achievement of the ideal of a system of perfect markets would increase [[economic efficiency]] and so raise  human [[welfare (economics)|welfare]]. However, the [[competition#The second-best|theory of the second best]] has demonstrated that is not necessarily true.
===The auctioneer analogy===
An analogy for the process by which a market brings  supply into equality with demand was put forward by the French economist, Leon Walras. He  described a market in which an imaginary auctioneer  invites offers to sell and offers to buy at an arbitrary starting price, and then announces a succession of  price revisions that  bring the amounts offered by buyers and sellers progressively closer together  until equality is reached - and allows no transactions to take place until that price is established <ref> Léon Walras ''Elements of Pure Economics'' (translated by William Jaffe from the 1874 original) Routledge 2007</ref>. The analogy is strictly applicable to "information-efficient"  markets, in which all participants are fully informed about the consequences of their agreements.
===The efficient market hypothesis===
The [[Financial economics#The efficient market hypothesis|efficient markets hypothesis]] stipulates that, in an information-efficient market,  all of the available information that is relevant to the price of an asset is already embodied in that price<ref>Paul Samuelson: ''Proof that Properly Anticipated Prices Fluctuate Randomly.'', Industrial Management Review, 6,  1965 </ref>. It is based upon the assumption  that investors react immediately to  any fresh information to buy or sell that asset.  A 1970 paper by Eugene Fama gave support to the hypothesis that stock markets are in that sense efficient<ref>[http://www.e-m-h.org/Fama70.pdf Eugene Fama: "Efficient Capital Markets: A Review of Theory and Empirical Work", ''Journal of Finance'' Vol 25 No 2, 1970]</ref>. Many of the subsequent developments in [[financial economics]] embodied that assumption, together with the  implied conclusion  that price variations on the markets for financial assets are random variations which could be represented by established [[probability distribution]]s. It was not until the [[crash of 2008]] that it was widely recognised that  major risks could occasionally arise from statistically unpredictable patterns of investor conduct,
===The financial instability hypothesis===
The [[Financial economics#The financial instability hypothesis|financial instability hypothesis]] <ref>[http://www.levy.org/pubs/wp74.pdf Hyman Minsky: ''The Financial Instability Hypothesis'', Working Paper No. 74, The Jerome Levy Economics Institute of Bard College, May 1992]</ref><ref> Hyman Minsky ''Stabilizing an Unstable Economy'', McGraw Hill, 1986</ref> was put forward by Hyman Minsky in 1992. It envisages the creation of an unstable regime as a result of the granting of credit during the early stages of a boom in  the expectation that repayments would be made from sources  that would  hopefully become available later. Professor Hyun Song Shin of Princeton University  also hypothesises that the financial system accumulates risks during a [[Boom (economics)|boom]]  which are realised  in the following [[Downturn (economic)| downturn]]<ref> Hyun Song Shin: ''Risk and Liquidity'', Chapter3, Clarendon Lectures in Finance, 2009, Oxford University Press, forthcoming[http://www.princeton.edu/~hsshin/ClarendonLectures.htm]</ref>,  but argues  that there is an indeterminate  threshold  level of disturbance below  which financial instability  does not take effect. He notes that a factor that distinguished the [[crash of 2008]] from the bursting of other [[Bubble (economics)|bubbles]] had been  introduction of [[securitisation]], which had concentrated risk on the banks by  inducing them to buy each other’s [[security (finance)|securities]] with borrowed money<ref>[http://www.voxeu.eu/index.php?q=node/3287 Hyun Song Shin ''Securitisation and Financial Stability'', Vox 18 March 2009]</ref>.


(See also the discussion of perfect competition in the article on [[competition]] and the discussion of the efficient market hypothesis in the article on [[financial economics]].)
==Policy implications==
===Financial regulation===
In response to the financial [[crash of 2008]], new measures of [[financial regulation]] are being introduced. "Microprudential" measures,  concerned with the stability of individual financial institutions, are being strengthened and new "macroprudential" measures,  concerned with the stability of the financial system as a whole are being added. A paper by the United States Department of the Treasury makes the point that "a narrow micro-prudential concern for the solvency of individual firms, while necessary, is by itself insufficient to guard against financial instability. In fact, actions taken to preserve one or a few individual banking firms may destabilize the rest of the financial system"<ref  name=treasury>[http://www.treas.gov/press/releases/docs/capital-statement_090309.pdf ''Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms'', US Treasury Department, September 2009]"</ref>.  A Bank of England  discussion paper goes further,  explaining  that  microprudential policymakers might impose severe lending restrictions to guard against individual bank failures,  whereas  macroprudential policies would take account of the long-term damage to the banking system and to  the economy that  could result from the consequent credit shortages<ref>[http://www.bankofengland.co.uk/publications/other/financialstability/roleofmacroprudentialpolicy091121.pdf ''The Role of Macroprudential Policy'', a discussion paper, Bank of England, November 2009]</ref>


==References==  
==References==  
 
{{reflist}}[[Category:Suggestion Bot Tag]]
<references/>

Latest revision as of 06:00, 16 September 2024

This article is developed but not approved.
Main Article
Discussion
Related Articles  [?]
Bibliography  [?]
External Links  [?]
Citable Version  [?]
 
This editable, developed Main Article is subject to a disclaimer.

A market is a social construct that enables sellers to trade with buyers. Markets provide the means of conveying information about products from sellers to potential buyers, and of information about the demand for products from buyers to potential sellers. They also provide for mutual confidence among traders that their bargains will be met.

The uses of the term

In political usage, 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.

In economics, the term 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. Market behaviour is known to be influenced by the characteristics of the institutions within which trading takes place.

Market characteristics

Markets can be categorised by their openness, structure, flexibility, stability, their degree of information asymmetry, and the difficulty of restricting access.

The term openness is here used to denote freedom from regulations concerning, for example, prices. quality and permission to trade.

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.

The concept of market flexibility is concerned with the speed with which a market price responds to a sudden change in the supply of, or demand for, its product. 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.

Information asymmetry occurs when the seller has information about the subject of a bargain that is not available to the buyer.

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.

Market organisation

The term "primary market" refers to one of a variety of organisational arrangements in which buyers deal directly with sellers. All early markets were of that sort. A later development was the creation of "secondary markets" in which transactions are made between specialist "dealers", acting on behalf of prospective buyers and sellers. One way of organising a primary market is to bring together numbers of mutually independent sellers with numbers of mutually independent buyers, either by attending a physical market place, or by using a telephonic or electronic communications centre. Another is to arrange an "auction", in which competing bids for the purchase of goods are made by groups of mutually independent buyers. There are many different ways of organising auctions, and they, too, can involve either attendance or communication.

The traditional way of organising a secondary market involved a physical location (termed an "exchange" or a "pit"), at which dealers matched ask prices with bid prices by "open outcry". That organisational form has now been replaced almost everywhere by the use of telephonic or electronic communication. The term "electronic market" has come to denote the use of computer software to make bargains automatically by electronically matching ask prices and bid prices. Settlement, involving the transfer of payments and purchases, takes place after the completion of bargains, and is usually the work of clearing houses.

Commercial markets

More detailed information about the operation of commercial markets is available in the article on financial system.

Stock exchanges

The major stock exchanges provide for regulated trading in securities that comply with regulations termed "listing". Many of them also provide second-level markets for the shares of smaller firms (such as London's "Alternative Investment Market[1])

Commodity markets

Commodity markets are exchanges where commodities of standardised quality are traded using standardised contracts. (Commodities are physical goods such as crude oil, and metals). More than forty commodity exchanges worldwide trade in over 100 commodities. Trading is confined to members and is commonly by "open outcry".

Foreign exchange markets

National currencies are traded against each other in countries all over the world and the transactions are facilitated by multiple clearance systems[2]. The activities of the traders in the different countries interact so strongly that the system behaves as though all trading were done in one centrally-administered exchange.

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. It embodies a concept of the process by which the supply and demand for a commodity, product or service are brought into equality. In the late 19th century, the English economist Alfred Marshall offered several definitions and gave a range of examples [3].

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.

The implications of the concept were explored in the 20th century by a mathematical exploration of the behaviour of a universal system of interconnected perfect markets in a condition of general equilibrium. The resulting theorems of welfare economics demonstrated that such a system would achieve a limited form of economic efficiency termed Pareto efficiency. That demonstration has been widely interpreted to imply that in practice the removal of obstacles to the achievement of the ideal of a system of perfect markets would increase economic efficiency and so raise human welfare. However, the theory of the second best has demonstrated that is not necessarily true.

The auctioneer analogy

An analogy for the process by which a market brings supply into equality with demand was put forward by the French economist, Leon Walras. He described a market in which an imaginary auctioneer invites offers to sell and offers to buy at an arbitrary starting price, and then announces a succession of price revisions that bring the amounts offered by buyers and sellers progressively closer together until equality is reached - and allows no transactions to take place until that price is established [4]. The analogy is strictly applicable to "information-efficient" markets, in which all participants are fully informed about the consequences of their agreements.

The efficient market hypothesis

The efficient markets hypothesis stipulates that, in an information-efficient market, all of the available information that is relevant to the price of an asset is already embodied in that price[5]. It is based upon the assumption that investors react immediately to any fresh information to buy or sell that asset. A 1970 paper by Eugene Fama gave support to the hypothesis that stock markets are in that sense efficient[6]. Many of the subsequent developments in financial economics embodied that assumption, together with the implied conclusion that price variations on the markets for financial assets are random variations which could be represented by established probability distributions. It was not until the crash of 2008 that it was widely recognised that major risks could occasionally arise from statistically unpredictable patterns of investor conduct,

The financial instability hypothesis

The financial instability hypothesis [7][8] was put forward by Hyman Minsky in 1992. It envisages the creation of an unstable regime as a result of the granting of credit during the early stages of a boom in the expectation that repayments would be made from sources that would hopefully become available later. Professor Hyun Song Shin of Princeton University also hypothesises that the financial system accumulates risks during a boom which are realised in the following downturn[9], but argues that there is an indeterminate threshold level of disturbance below which financial instability does not take effect. He notes that a factor that distinguished the crash of 2008 from the bursting of other bubbles had been introduction of securitisation, which had concentrated risk on the banks by inducing them to buy each other’s securities with borrowed money[10].

Policy implications

Financial regulation

In response to the financial crash of 2008, new measures of financial regulation are being introduced. "Microprudential" measures, concerned with the stability of individual financial institutions, are being strengthened and new "macroprudential" measures, concerned with the stability of the financial system as a whole are being added. A paper by the United States Department of the Treasury makes the point that "a narrow micro-prudential concern for the solvency of individual firms, while necessary, is by itself insufficient to guard against financial instability. In fact, actions taken to preserve one or a few individual banking firms may destabilize the rest of the financial system"[11]. A Bank of England discussion paper goes further, explaining that microprudential policymakers might impose severe lending restrictions to guard against individual bank failures, whereas macroprudential policies would take account of the long-term damage to the banking system and to the economy that could result from the consequent credit shortages[12]

References