Markets

The term markets are not new to you. We speak of the supermarket, the stock market, the market for teachers, engineers, etc. However, we are going to define the term market more broadly. We will refer to the market as the arena or medium in which buyer and seller interact or meet.

This definition is purposely broad since a market need not be limited to a specific geographic area. For example, the market for wide-body jet planes such as Boeing 747 or the DC-10 is worldwide. The job market for engineers may include diverse locations such as Tehran, Iran, Seattle, Washington, Omaha Nebraska. In contrast to this, your town may have a “farmer’s market” which is a specific location where the local garden farmers bring in their produce during the growing season.

The key element of a market is therefore not it’s location, but rather the existence of the demanders and suppliers interested in buying and selling of goods and services.

In an economy such as ours, the market plays an important role in determining what will be produced, how production will occur, and who does the producing. Prices, determined in the market, are a key element in answering this question.

It is in the context of the market that supply and demand interact to determine price. Once determined, prices are an important mechanism for allocating resources and rationing goods. In other words, prices help solve economic problems of what commodities to produce. Prices, however, will not be determined in markets unless certain conditions prevail.

The condition necessary for price determination

There are some commodities that are bought and sold in the market where there are many buyers and sellers. The organized stock exchange, commodity exchange, and markets for foreign currencies are examples. At the same time, however, there are markets that are not as well organized.

To explain how a market operates, we are going to construct a simplified model which may not reflect the conditions of any specific real market; nevertheless, it will give us insight in explaining how prices are determined in the real world.

This model is called the model of the competitive market and it operates under the following conditions:

1. There are many buyers and sellers.

2. There is free entry or exit. ( This means that sellers, for example, may enter the market at will. They are not prevented from entering by law or custom. ) If these conditions prevail, it may not be necessary to have many buyers and sellers actually in the market -- as long as, the possibility of potential buyers and sellers entering the market exists.

3. A clearly identified product is exchanged in the market. This means that the commodity is basically the same qualitatively.

4. Buyers and sellers have some notion of the prices at which the product has been selling in the recent past.

Competition, as identified by the existence of the above conditions, is clearly a matter of degree. Some markets then are more “competitive” than others; therefore, the effectiveness with which price is determined also differs from market to market.

Finally, we are ready to put the concepts of supply, demand, and competitive market together. The purpose will be to determine the price of the commodity exchanged.

Market Equilibrium

A market is said to be in equilibrium when the quantity supplied and the quantity demanded of a commodity are equal. Table 1 shows the hypothetical market supply and demand schedules for blanks CDs. There is only one price at which the quantity supplied equals the quantity demanded. This price is P20. It is the equilibrium price or the market-clearing price as it is also called.

This price can easily be identified in figure 1 as the price at which the market supply and demand curve intersect.

Notice that the market demand curve and the market supply curve are plotted on the same graph. The data for the market demand curve come from columns 1 and 2 of Table 1, and the data for the market supply curve come from columns 1 and 3 of this table.

At any price above the equilibrium price, a surplus exists; that is, the quantity supplied is greater than the quantity demanded. At any price below the equilibrium price, a shortage exists; that is, the quantity demanded exceeds the quantity supplied.

Table 1

Market Supply and Demand

Blank Cd’s

Price per Blank Cd’s	Total Quantity demanded per week	Total quantity supplied per week
P40	1,000	11,000
30	4,000	9,000
20	7,000	7,000
10	10,000	5,000

Surplus

Note on the schedule or graph the quantity demanded and quantity supplied when the price of blanks CDs is P40. The quantity demanded is 1,000 while the quantity supplied is 11,000. Therefore, at the price of P40, a surplus of 10,000 blank CDs exists.

A surplus exists when at a given price, the quantity supplied is greater than the quantity demanded.

To prevent their shelves from being overstocked, the sellers of Blank CDs will want to reduce their excess supply of blank CDs. One way to do this is to lower their price. As the price falls, more people will be willing and able to buy. At P20 the market will be cleared; that is, the quantity demanded by the costumers and the quantity sellers are willing and able to offer for sale will be equal.

Shortage

Note on the schedule or graph the quantity demanded and the quantity supplied when the price of blanks CDs is P10. the quantity demanded is 10,000 and the quantity supplied is 5,000. a shortage of 5,000 blank cards exists at that price.

A shortage occurs when a given price quantity supplied is less than the quantity demanded.

When the price is P10, people will want to buy more blanks CDs that are available. As the buyers competitively bid up the price, some will be unable or unwilling to buy at the new prices. At the low price, manufacturers do not want to supply as much as demanded. As the price rises, new manufacturers will be encouraged to begin to supply and old ones will supply more. At P20, the amount people are able to buy is equal to the amount manufacturers are willing and able to sell.

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