Concept of Market & Market Mechanism in Economics

Meaning of Market

The word Market comes from the Latin mercatus, which means trading, buying or selling at an appointed time or place.

A market is not necessarily a marketplace. It is a context or background where buying and selling are taking place. The haat, bazaar and mandi, the shop and the mall are markets. But online or telephonic sale and purchase, which is quite common these days, are also market transactions.

The distinguishing feature of the market is that market transactions are exchanges, usually performed through the medium of money.

The seller (who is sometimes though not always, the producer) of certain commodities/ services brings them to the market and offers certain quantities of them at a certain price. He thus supplies them in the market. The prospective buyer comes to the market wanting to get certain commodities/ services at a certain price. He thus demands them in the market. If the demand of the buyer and the supply of the seller match at a certain configuration of price and quantity, the transaction takes place. If not, it does not.

The transaction is thus both a sale and a purchase. It is a sale from the point of view of the Seller (producer), that is, from the Supply side. It is purchased from the point of view of the Buyer, that is, the Demand side.

The transaction has two aspects or dimensions to it, viz., a quantity and a price. For example, the seller is agreeable to selling 2 kegs of rice at the rate of Rest 50, and the buyer finds this offer reasonable. “Two kgs of rice at Rs 50” is then the description of the transaction. The total amount spent by the buyer/ consumer and received by the seller/supplier is thus Rs 100 (50 x 2). This is called the Expenditure from the buyer’s point of view and the Revenue from the seller’s. The transaction configuration and the total expenditure/revenue are thus distinct concepts.

The transaction configuration is known as the Equilibrium configuration, or simply, Equilibrium. It is called so because it represents a matching or balancing of two aspects– the Buyer’s and the Seller’s, that is, the Demand side and the Supply side.

Markets in Micro and Macro Theory

There is an essential difference in the approach in which Micro-Economics and Macro-Economics look at markets.

In Macro-Economics, the markets concerned are overall or aggregate in nature, e.g., the Goods market and the Money Market. But Micro-Economic looks at markets in the sense of individual buyers (consumers or households) and individual sellers (producers or firms) coming together to perform their respective roles in the market transactions.

It is concerned with whether there are numerous buyers and sellers or just a few ( or even one), whether the product (good, commodity, or service) is homogeneous or differentiated, whether there is perfect information about the products(output) and factors of production (input), whether the factors (inputs) can freely move between alternative uses and such conditions. Depending upon the configuration of such conditions, the market takes different forms, such as Perfect Competition, Monopolistic Competition, Monopoly, and so on. A large part of Micro-Economics is devoted to the study of these market forms.

Market and Capitalism

The market is a feature of the Capitalist system. In the Feudal era, tradition and social customs governed economic life. Peasants or serfs worked in the fields of the Kings or the Lords and deposited the crops with them, keeping only what traditionally was their subsistence requirement. They offered tributes rather than performing exchange. In the course of time, Feudalism gave way to Capitalism. The market exchange became the prevalent practice. No historian can ever say exactly how the market system came into being. “Nobody invented it” said Samuelson. : It just evolved.” (Economics, Paul. A Samuelson, p 42)

Markets are not supposed to be there in a Socialist or Communist country. When the Bolshevik Revolution took place in 1917, and the USSR was born, there were experiments to do away with the market system altogether. Central Planning was developed to substitute for it. But there were many practical problems. After 1991, the USSR collapsed, and with it, any experiments of economic life were without markets.

Because of the importance of the market, Capitalism is also called Market Economy.

Working of the Market – Price Mechanism: Demand and Supply

How does a Market work? It works through prices. This working of the market through the prices is known as the Market Mechanism or Price Mechanism. It is an all-important concept in Micro-Economics – an elaborate yet unconscious device to coordinate the information and actions of countless individuals and even organizations.

In any economy that has developed from Feudalism to Capitalism, producers do not collect information directly about the wants of consumers. Yet, the consumers find all that they wish to Buy in the market. Consumers, too, do not get too bothered about their wants being satisfied. They find that they have more or less been produced and brought to the market.

There exists a certain degree of information and organization in the market without any planner, market researcher or operator. How?

For each commodity, be it wheat or computers, textiles or medicines, there exists a market in which its consumers and producers, buyers and sellers have dealings with one another which they settle in terms of a mutually agreed quantity at a mutually agreed price. That price brings the quantities demanded by buyers into equality with the quantities supplied by sellers. This it does because of its variability or flexibility. Where prices are fixed or `sticky’, the price mechanism does not work so well.

Market Mechanism (Price Mechanism) and Social Welfare

The Price Mechanism is supposed to lead to the best outcome for the individual as well as the society. In his book An Enquiry into the Nature and Causes of the Wealth of Nations (1776), Adam Smith stated that when everyone in a market economy acts in his individual self-interest, it is as if an Invisible Hand (like that of God’s) ensured that social welfare is maximized,

…every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who were affected to trade for the public good.

(Adam Smith and the Invisible Hand by Helen Joyce Source)

Thus Adam Smith was so impressed with the Market Mechanism that he attributed almost a spiritual significance to it.

Market Failure or Malfunctioning of the Market Mechanism (Price mechanism)

The Market Mechanism can, however, fail and create chaos under circumstances like the following:

• If there are market imperfections, e.g., under Monopoly and Monopolistic Competition (a market form where the buyers are forced to buy from just one seller or a few), the price mechanism does not work well.
• If there are governmental restrictions, and prices are fixed or determined by the government (through Price Floors, Price Ceilings and Minimum Wage Laws), again, the price mechanism does not work well.
• If the commodity concerned is `indivisible’ or very big (e.g., public utilities like parks and highways), price (which is a per unit concept) may not allocate it efficiently.

Read More- Microeconomics

1. Microeconomics: Definition, Meaning and Scope
2. Methods of Analysis in Economics
3. Problem of Choice & Production Possibility Curve
4. Concept of Market & Market Mechanism in Economics
5. Concept of Demand and Supply in Economics
6. Concept of Equilibrium & Dis-equilibrium in Economics
7. Cardinal Utility Theory: Concept, Assumptions, Equilibrium & Drawbacks
8. Ordinal Utility Theory: Meaning & Assumptions
9. Indifference Curve: Concept, Properties & Shapes
10. Budget Line: Concept & Explanation
11. Consumer Equilibrium: Ordinal Approach, Income & Price Consumption Curve
12. Applications of Indifference Curve
13. Measuring Effects of Income & Excise Taxes and Income & Excise Subsidies
14. Normal Goods: Income & Substitution Effects
15. Inferior Goods: Income & Substitution Effects
16. Giffen Paradox or Giffen Goods: Income & Substitution Effects
17. Concept of Elasticity: Demand & Supply
18. Demand Elasticity: Price Elasticity, Income Elasticity & Cross Elasticity
19. Determinants of Price Elasticity of Demand
20. Measuring Price Elasticity of Demand
21. Price Elasticity of Supply and Its Determinants
22. Revealed Preference Theory of Samuelson: Concept, Assumptions & Explanation
23. Hicks’s Revision of Demand Theory
24. Choice Involving Risk and Uncertainty
25. Inter Temporal Choice: Budget Constraint & Consumer Preferences
26. Theories in Demand Analysis
27. Elementary Theory of Price Determination: Demand, Supply & Equilibrium Price
28. Cobweb Model: Concept, Theorem and Lagged Adjustments in Interrelated Markets
29. Production Function: Concept, Assumptions & Law of Diminishing Return
30. Isoquant: Assumptions and Properties
31. Isoquant Map and Economic Region of Production
32. Elasticity of Technical Substitution
33. Law of Returns to Scale
34. Production Function and Returns to Scale
35. Euler’s Theorem and Product Exhaustion Theorem
36. Technical Progress (Production Function)
37. Multi-Product Firm and Production Possibility Curve
38. Concept of Production Function
39. Cobb Douglas Production Function
40. CES Production Function
41. VES Production Function
42. Translog Production Function
43. Concepts of Costs: Private, Social, Explicit, Implicit and Opportunity
44. Traditional Theory of Costs: Short Run
45. Traditional Theory of Costs: Long Run
46. Modern Theory Of Cost: Short-run and Long-run
47. Modern Theory Of Cost: Short Run
48. Modern Theory Of Cost: Long Run
49. Empirical Evidences on the Shape of Cost Curves
50. Derivation of Short-Run Average and Marginal Cost Curves From Total Cost Curves
51. Cost Curves In The Long-Run: LRAC and LRMC
52. Economies of Scope
53. The Learning Curve
54. Perfect Competition: Meaning and Assumptions
55. Perfect Competition: Pricing and Output Decisions
56. Perfect Competition: Demand Curve
57. Perfect Competition Equilibrium: Short Run and Long Run
58. Monopoly: Meaning, Characteristics and Equilibrium (Short-run & Long-run)
59. Multi-Plant Monopoly
60. Deadweight Loss in Monopoly
61. Welfare Aspects of Monopoly
62. Price Discrimination under Monopoly: Types, Degree and Equilibrium
63. Monopolistic Competition: Concept, Characteristics and Criticism
64. Excess Capacity: Concept and Explanation
65. Difference Between Perfect Competition and Monopolistic Competition
66. Oligopoly Market: Concept, Types and Characteristics
67. Difference Between Oligopoly Market and Monopolistic Market
68. Oligopoly: Collusive Models- Cartel & Price Leadership
69. Oligopoly: Non-Collusive Models- Cournot, Stackelberg, Bertrand, Sweezy or Kinked Demand Curve
70. Monopsony Market Structure
71. Bilateral Monopoly Market Structure
72. Workable Competition in Market: Meaning and Explanation
73. Baumol’s Sales Revenue Maximization Model
74. Williamson’s Model of Managerial Discretion
75. Robin Marris Model of Managerial Enterprise
76. Hall and Hitch Full Cost Pricing Theory
77. Andrew’s Full Cost Pricing Theory
78. Bain’s Model of Limit Pricing
79. Sylos Labini’s Model of Limit Pricing
80. Behavioural Theory of Cyert and March
81. Game Theory: Concept, Application, and Example
82. Prisoner’s Dilemma: Concept and Example