Market

What It Means

In economics a market is a place or system that allows buyers and sellers of goods and services to interact with one another. Markets used to be specific physical locations. For instance, in the eighteenth century American farmers typically took their harvested goods to market, a site in a town where sellers and buyers gathered to do business. As the world modernized, the meaning of the term market expanded. The term still refers to such specific locations (a present-day example would be a flea market or a farmers’ market), but in economics it more commonly refers to any geographical region or electronic arrangement in which buyers and sellers interact with one another to establish the same prices for the same items.

In present-day New York City, for example, there is a single market for real estate. The prices of houses and apartments across the city rise and fall together, depending on the collective action of all the buyers and sellers within that market. Though the real-estate market in another American city might be affected by national trends that similarly affect the New York real-estate market, the price of real estate differs dramatically from city to city. By contrast the market for shares of stock (a portion of company ownership that can be bought and sold) in American companies is global. A person in Japan who wants to buy stock in Microsoft will pay the same price as a person in Ohio.

All markets share one central characteristic: they supply a site where sellers and buyers can interact. The simple farmers’ markets of the eighteenth century provided a place for the interaction of the forces of supply (the amount of any good or service that a seller is willing to sell at a given price) and demand (the amount of any good or service that buyers are willing to buy at a given price), just as the high-tech stock markets of today do. The competing desires of buyers and sellers, rather than a central authority figure or a government, are responsible for determining the prices of goods and services in any market. Sellers want to make a profit, so the higher the price of any particular product, the more of it the seller tends to produce (the reverse holds true when prices fall). Buyers want to pay as little as possible, so the higher the price of a certain product, the less of it buyers tend to buy (again, the reverse holds true when prices fall). Prices therefore determine how much of any given product is manufactured. Prices also determine how (and how well) something will be produced, as well as the degree to which various people benefit from the economic activity that goes on in the market.

Capitalism, the dominant economic system in the world today, is built on two key pillars: the right of individuals to own private property and the reliance on markets, rather than any central authority, to dictate the production and distribution of goods and services. Markets therefore substantially determine the shape of the contemporary world.

When Did It Begin

Public marketplaces existed prior to the rise of capitalism, which occurred between the sixteenth and the eighteenth centuries in Europe. Before capitalism took hold, however, much economic activity was directly controlled by ruling authority figures rather than by such market forces as supply and demand. While people bought and sold goods at marketplaces in the ancient and medieval worlds, the prices paid for goods and services were likely to have been set by rulers rather than by the competing interests of buyers and sellers. In such cases economic activity may have been motivated not by a desire for gain but by law. If a ruler demanded, for example, that a farmer grow wheat on his land and sell it for a certain price for the benefit of society, then that farmer had no choice but to engage in that activity and sell for that price.

Many economists agree, however, that public fairs held in medieval Europe were one origin of the market system. A farmer in fifteenth-century England might have been forced to hand over a certain amount of his crop to his aristocratic landlord, but he might also have engaged in the production of profitable sidelines, such as the brewing of beer or the making of cheese. This farmer might then have taken his surplus crop, together with the fruits of these side businesses, to a public fair, where he was free to sell his products to buyers for personal gain.

The rise of capitalism was caused by a complex set of factors. One of the most important of these factors was the centralization and growth of European nation-states between the sixteenth and the eighteenth centuries. European countries, which had formerly been divided into smaller kingdoms, became more unified during this time, and they competed against one another for power. This rivalry required raising large armies and seizing colonies around the world, activities that could not be undertaken without vast amounts of money. Nations could produce more wealth by allowing individuals to own property and pursue a profit in various markets than by keeping ownership and wealth locked up in the hands of a small number of aristocrats (those belonging to a privileged class that lived partly on inherited family money).

More Detailed Information

At the foundation of all markets are the forces of supply and demand. Again, supply is the quantity of any good or service that sellers are willing to sell over a range of prices, and demand is the quantity of any good or service that buyers are willing to buy over a range of prices. The law of supply states that as the price of a good rises, sellers will want to supply more of that good because they want to maximize their profits; and the law of demand states that as the price of a good rises, buyers will want to buy less of that good because they want to keep as much of their money as possible to ensure their well-being. Through trial and error in a market situation, sellers and buyers measure their desires to sell and buy until eventually a price results that is acceptable to both. When this happens, the correct quantities of goods are produced in the most efficient ways, and both sellers and buyers get what they want.

For a concrete example of how markets distribute information and promote efficiency, imagine that an existing automobile company is introducing a new sports car. When the company attempts to calculate a price, it will first determine how much it must charge consumers in order to recover the money it has put into designing, engineering, producing, marketing, and distributing the new model. Beyond this basic level of costs, the company will want to maximize its profits, so it will set the highest price that the car market will bear, which requires keeping in mind the desires of consumers. Those consumers likely to be interested in the new-model sports car will probably not have an unlimited interest in it. If the model is unveiled and the price is generally seen as too high, consumers will look to other sports-car models or refrain from buying a car altogether. If the price is lower than it could be, given consumer demand for the car, the company will not maximize its profits.

Once the car model enters the market, consumers begin communicating to the car company through the amount of purchases they make. If, for instance, sales are disappointing at the first price set by the company, price X, then the market is sending the company a clear message that demand is weak at price X. Based on this information, the company will lower the price by several thousand dollars to price Y. At price Y sales pick up and remain steady over several months. Assuming that price Y still brings in an amount of money well above the car company’s production costs, the company now understands how much it can charge, based on consumer demand, at the same time ensuring a satisfactory level of profits.

Further, the company will weigh this information against its own ability to make profits in other ways. For instance, if price Y represents a smaller amount of profit than the company can bring in by selling its economy-car models, then it may want to reduce the number of new sports cars it manufactures and increase the number of economy cars it produces. If the company has 10 different car models, it will use the information on each model transmitted to it via the market to make its future decisions about which models to produce, how many of them to produce, and how to produce them (balancing efficiency and quality).

This basic pattern holds true across the entire economy. Buyers and sellers communicate with one another through prices, and the exchange of information allows each to make the countless individual decisions that add up, every day, to the overall economy. Without markets this same exchange of information would be extremely time-consuming and inefficient, and very little economic activity (by contemporary standards) could take place.

Recent Trends

After the Great Depression (the severe economic crisis that impoverished much of the United States between 1929 and about 1939) people generally had less confidence in markets to regulate the economy and provide for the greater good. In response, the U.S. government began intervening in the economy as a matter of policy, hoping to prevent other dramatic crises in the future. This trend continued into the 1970s, but economic stagnation at that time was blamed on the very government intervention that had previously helped the country out of the depression.

In the 1980s conservative politicians, such as President Ronald Reagan, routinely called for smaller government, the idea being that the smaller the size of the government, the less effect government could have on the economy. The belief that government is often harmful to the economy gained further momentum in the 1990s and the early years of the new century. While there are serious economic arguments to be made for and against government involvement in the economy, many people during this time simply took it on faith that free markets were always preferable to government-managed capitalism.